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About the Authors

STEPHEN A. ROSS Sloan School of Management, Massachusetts Institute of Technology

Stephen A. Ross was the Franco Modigliani Professor of Finance and Economics at the
Sloan School of Management, Massachusetts Institute of Technology. One of the most
widely published authors in finance and economics, Professor Ross was widely recognized
for his work in developing the Arbitrage Pricing Theory and his substantial contributions
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 also served as an associate editor of several academic
and practitioner journals. He was a trustee of CalTech. He died suddenly in March of 2017.

RANDOLPH W. WESTERFIELD Marshall School of Business, University of Southern California

Randolph W. Westerfield is Dean Emeritus of the University of Southern California’s
Marshall School of Business and is the Charles B. Thornton Professor of Finance Emeritus.
Professor Westerfield came to USC from the Wharton School, University of Pennsylvania,
where he was the chairman of the finance department and member of the finance faculty
for 20 years. He is a member of the Board of Trustees of Oak Tree Capital Mutual Funds.
His areas of expertise include corporate financial policy, investment 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 finance and economics literatures in such jour-
nals as the Quarterly Economic Journal, The Journal of Finance, The Journal of Financial
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 corpo-
rate insiders earn abnormal profits from their trades and that regulation has little effect on
these profits. He also has made contributions concerning initial public offerings, regulation
of utilities, the behavior of market makers, the fluctuation of gold prices, the theoretical
effect of inflation on interest rates, the empirical effect of inflation on capital asset prices,
the relationship between small-capitalization stocks and the January effect, and the capital
structure decision.

BRADFORD D. JORDAN Gatton College of Business and Economics, University of Kentucky

Bradford D. Jordan is Professor of Finance and holder of the duPont Endowed Chair
in Banking and Financial Services. He has a long-standing interest in both applied and
theoretical issues in corporate finance and has extensive experience teaching all levels of
corporate finance and financial management policy. Professor Jordan has published numer-
ous articles on issues such as cost of capital, capital structure, and the behavior of security
prices. He is a past president of the Southern Finance Association and is coauthor of
Fundamentals of Investments: Valuation and Management, 8th edition, a leading investments
text, also published by McGraw-Hill Education.

vii
Preface

T he teaching and the practice of corporate finance are more challenging and exciting
than ever before. The last decade has seen fundamental changes in financial markets
and financial instruments. In the early years of the 21st century, we still see announce-
ments in the financial press about takeovers, junk bonds, financial restructuring, initial
public offerings, bankruptcies, and derivatives. In addition, there are the new recognitions
of “real” options, private equity and venture capital, subprime mortgages, bailouts, and
credit spreads. As we have learned in the recent global credit crisis and stock market col-
lapse, the world’s financial markets are more integrated than ever before. Both the theory
and practice of corporate finance have been moving ahead with uncommon speed, and our
teaching must keep pace.
These developments have placed new burdens on the teaching of corporate finance.
On one hand, the changing world of finance makes it more difficult 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 finance and make the theory come to life with con-
temporary examples. Increasingly, many of these examples are outside the United States.
All too often, the beginning student views corporate finance as a collection of unre-
lated topics that are unified largely because they are bound together between the covers of
one book. We want our book to embody and reflect the main principle of finance: Namely,
good financial decisions will add value to the firm and to shareholders and bad financial
decisions will destroy value. The key to understanding how value is added or destroyed is
cash flows. To add value, firms must generate more cash than they use. We hope this simple
principle is manifest in all parts of this book.

The Intended Audience of This Book

This book has been written for the introductory courses in corporate finance at the MBA
level and for the intermediate courses in many undergraduate programs. Some instructors
will find 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 difficult 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 12th Edition

THE TAX CUTS AND JOBS ACT (TCJA) IS INCORPORATED THROUGHOUT
There are six primary areas of change and they will be reflected in the 12th edition:
1. Corporate tax. The new, flat-rate 21 percent corporate rate is discussed and compared
to the old progressive system. The new rate is used throughout the text in examples
and problems. Entities other than C corporations still face progressive taxation, so the
discussion of marginal versus average tax rates remains relevant and is retained.

viii
 2. Bonus depreciation. For a limited time, businesses can take a 100 percent deprecia-
tion charge the first year for most non-real estate, MACRS-qualified investments. This
“bonus depreciation” ends in a few years and MACRS returns, so the MACRS mate-
rial remains relevant and is retained. The impact of bonus depreciation is illustrated in
various problems.
3. Limitations on interest deductions. The amount of interest that may be deducted for
tax purposes is limited. Interest that cannot be deducted can be carried forward to
future tax years (but not carried back; see next).
4. Carrybacks. Net operating loss (NOL) carrybacks have been eliminated and NOL
carryforward deductions are limited in any one tax year.
5. Dividends-received tax break. The tax break on dividends received by a corporation has
been reduced, meaning that the portion subject to taxation has increased.
6. Repatriation. The distinction between U.S. and non-U.S. profits essentially has been
eliminated. All “overseas” assets, both liquid and illiquid, are subject to a one-time
“deemed” tax.
With the 12th edition, we’ve also included coverage of
●● Inversions.

●● Negative interest rates.

●● NYSE market operations.

●● Direct listings and cryptocurrency initial coin offerings (ICOs).

●● Regulation CF.

●● Brexit.

●● Repatriation.

●● Changes in lease accounting.

In addition, each chapter has been updated and, where relevant, “internationalized.” We try
to capture the excitement of corporate finance with current examples, chapter vignettes,
and openers. Spreadsheet applications are spread throughout.

ix
 Students—study more efficiently, retain more
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Pedagogy

In this edition of Corporate Finance, we 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 valuable learning tools and support to help students
succeed in learning the fundamentals of financial management.

Chapter Opening Vignettes

Each chapter begins with a contemporary vignette that highlights the concepts in
the chapter and their relevance to real-world examples.

10 PART III: RISK

Lessons from Market History

With the S&P 500 Index returning about 19 percent and
the NASDAQ Composite Index up about 28 percent in
2017, stock market performance overall was very good.
In particular, investors in biopharmaceutical company
Madrigal Pharmaceuticals, Inc., had to be happy about the
These examples show that there were tremendous
potential profits to be made during 2017, but there was
also the risk of losing money—and lots of it. So what
should you, as a stock market investor, expect when you
invest your own money? In this chapter, we study more

ExcelMaster Icons
516 percent gain in that stock and investors in genomic than eight decades of market history to find out.
therapy company Sangamo Therapeutics had to feel pretty
good following that company’s 438 percent gain. Of
Please visit us at rwjcorporatefinance.blogspot.com for
course, not all stocks increased in value during the year.
Stock in Sears Holdings fell 61 percent during the year and
the latest developments in the world of corporate finance.
Topics covered in the comprehensive
stock in Under Armour dropped 48 percent.
ExcelMaster supplement (in Connect) are
indicated by ALLOCATED
an icon in the margin.
172 ■■■ PART II Valuation and Capital Budgeting

COSTS
Frequently a particular expenditure benefits a number of projects. Accountants allocate
10.1 Returns this cost across the different projects when determining income. However, for capital
budgeting purposes, this allocated cost should be viewed as a cash outflow of a project
only if it is an incremental cost of the project.
DOLLAR RETURNS
EXAMPLE
Excel Suppose the Video Concept Company has several thousand shares of stock outstanding 6.5 Allocated Costs The Voetmann Consulting Corp. devotes one wing of its suite of offices to a
Master and you are a shareholder. Further suppose that you purchased some of the shares of library requiring a cash outflow of $100,000 a year in upkeep. A proposed capital budgeting
coverage online project is expected to generate revenue equal to 5 percent of the overall firm’s sales. An
stock in the company at the beginning of the year; it is now year-end and you want to executive at the firm, David Pedersen, argues that $5,000 (= .05 × $100,000) should be viewed
figure out how well you have done on your investment. The return you get on an invest- as the proposed project’s share of the library’s costs. Is this appropriate for capital budgeting?
The answer is no. One must ask what the difference is between the cash flows of the entire
ment in stocks, like that in bonds or any other investment, comes in two forms. firm with the project and the cash flows of the entire firm without the project. The firm will spend
$100,000 on library upkeep whether or not the proposed project is accepted. Because accep-
As the owner of stock in the Video Concept Company, you are a part owner of the
How did the market tance of the proposed project does not affect this cash flow, the cash flow should be ignored

do today? Find out at company. If the company is profitable, it generally could distribute some of its profits to
finance.yahoo.com. the shareholders. Therefore, as the owner of shares of stock, you could receive some cash,
called a dividend, during the year. This cash is the income component of your return. In
addition to the dividends, the other part of your return is the capital gain—or, if it is nega-
tive, the capital loss (negative capital gain)—on the investment.
For example, suppose we are considering the cash flows of the investment in
coverage online
Figure 10.1, showing that you purchased 100 shares of stock at the beginning of the year
at a price of $37 per share. Your total investment, then, was:
C0 = $37 × 100 = $3,700
299
when calculating the NPV of the project. Suppose the project has a positive NPV without the
allocated costs but is rejected because of the allocated costs. In this case, the firm is losing
potential value that it could have gained otherwise.
6.2 The Baldwin Company: An Example
Excel We next consider the example of a proposed investment in machinery and related items.
Master Our example involves the Baldwin Company and colored bowling balls.
The Baldwin Company, originally established 16 years ago to make footballs, is now
a leading producer of tennis balls, baseballs, footballs, and golf balls. Nine years ago, the
company introduced “High Flite,” its first line of high-performance golf balls. Baldwin
management has sought opportunities in whatever businesses seem to have some potential
for cash flow. Recently W. C. Meadows, vice president of the Baldwin Company, identi-
fied another segment of the sports ball market that looked promising and that he felt was
not adequately served by larger manufacturers. That market was for brightly colored bowl-
ing balls, and he believed many bowlers valued appearance and style above performance.
He also believed that it would be difficult for competitors to take advantage of the oppor-
tunity because of both Baldwin’s cost advantages and its highly developed marketing skills.
As a result, the Baldwin Company investigated the marketing potential of brightly
colored bowling balls. Baldwin sent a questionnaire to consumers in three markets: Phila-
delphia, Los Angeles, and New Haven. The results of the three questionnaires were much
better than expected and supported the conclusion that the brightly colored bowling balls
could achieve a 10 to 15 percent share of the market. Of course, some people at Baldwin
complained about the cost of the test marketing, which was $250,000. (As we shall see
later, this is a sunk cost and should not be included in project evaluation.)
In any case, the Baldwin Company is now considering investing in a machine to
produce bowling balls. The bowling balls would be manufactured in a warehouse owned
by the firm and located near Los Angeles. This warehouse, which is vacant, and the land
can be sold for $150,000 after taxes.
Working with his staff, Meadows is preparing an analysis of the proposed new prod-
uct. He summarizes his assumptions as follows: The cost of the bowling ball machine is
$100,000 and it is expected to last five years. At the end of five years, the machine will be

xii
 240 ■■■ PART II Valuation and Capital Budgeting

Figure 8.2
Interest Rate Risk
and Time to Maturity

2,000
$1,768.62

30-year bond

Bond value ($)

1,500

$1,047.62 1-year bond

1,000 278 ■■■ PART II Valuation and Capital Budgeting
$916.67

500 $502.11
Figures and Tables
In this case, total return works out to be:
R = $1/$20 + .10
= .05 + .10
This text makes extensive use of real data and
= .15, or 15%
This stock has an expected return of 15 percent.
5 10
Interest rate (%)
15 20
presents them
We can verify in various
this answer figures
by calculating the and
price in one year, Ptables. Ex-
, using 15 percent
1
as the required expected return. Because the dividend expected to be received in one year
Value of a Bond with a 10 Percent Coupon Rate for Different Interest Rates and Maturities
planations in the
is $1 and the expected growth narrative,
rate of dividends isexamples, andexpected
10 percent, the dividend end-to
Time to Maturity be received in two years, D , is $1.10. Based on the dividend growth model, the stock
of-chapter problems will refer to many of these
2
Interest Rate 1 Year 30 Years price in one year will be:
5% $1,047.62 $1,768.62
P = D /(R − g)
10
15
1,000.00
956.52
1,000.00
671.70
exhibits. 1 2
= $1.10/(.15 − .10)
20 916.67 502.11 = $1.10/.05
= $22
Notice that this $22 is $20 × 1.1, so the stock price has grown by 10 percent, as it should.
This means the capital gains yield is 10 percent, which equals the growth rate in dividends.
What is the investor’s total expected return? If you pay $20 for the stock today, you
tells us that a relatively small change in interest rates will lead to a substantial change will get a $1 dividend at the end of the year, and you will have a $22 − 20 = $2 gain.
in the bond’s value. In comparison, the 1-year bond’s price is relatively insensitive to Your dividend yield is $1/$20 = .05, or 5 percent. Your capital gains yield is $2/$20 =
interest rate changes. .10, or 10 percent, so your total expected return would be 5 percent + 10 percent = 15
Intuitively, shorter-term bonds have less interest rate sensitivity because the $1,000 percent, as we calculated above.
face amount is received so quickly. The present value of this amount isn’t greatly affected To get a feel for actual numbers in this context, consider that, according to the 2017
by a small change in interest rates if the amount is received in, say, one year. However, Value Line Investment Survey, Procter & Gamble’s dividends were expected to grow by
even a small change in the interest rate, once compounded for, say, 30 years, can have a 6.5 percent over the next 5 or so years, compared to a historical growth rate of 6.0 percent
significant effect on present value. As a result, the present value of the face amount will over the preceding 5 years and 8.5 percent over the preceding 10 years. In 2017, the
be much more volatile with a longer-term bond. projected dividend for the coming year was given as $2.85. The stock price at that time
The other thing to know about interest rate risk is that, like many things in finance was $94.40 per share. What is the expected return investors require on P&G? Here, the
and economics, it increases at a decreasing rate. A 10-year bond has much greater interest dividend yield is 3.0 (= $2.85/$94.40) percent and the capital gains yield is 6.5 percent,
rate risk than a 1-year bond has. However, a 30-year bond has only slightly greater interest giving a total required return of 9.5 percent on P&G stock.
rate risk than a 10-year bond.
The reason that bonds with lower coupons have greater interest rate risk is essen-EXAMPLE
tially the same. As we discussed earlier, the value of a bond depends on the present
Examples
value of both its coupons and its face amount. If two bonds with different coupon
rates have the same maturity, the value of the lower-coupon bond is proportionately
9.5 Calculating the Required Return Pagemaster Enterprises, the company examined in
Example 9.4, has 1,000,000 shares of stock outstanding. The stock is selling at $10. What is the
required return on the stock?
more dependent on the face amount to be received at maturity. As a result, its value The payout ratio is the ratio of dividends/earnings. Because Pagemaster’s retention ratio is
Separate called-out examples are integrated
will fluctuate more as interest rates change. Put another way, the bond with the higher 40 percent, the payout ratio, which is 1 – Retention ratio, is 60 percent. Recall both that Page-
master reported earnings of $2,000,000 and that the firm’s growth rate is 6.4 percent.
throughout the chapters. Each example Earnings a year from now will be $2,128,000 (= $2,000,000 × 1.064), implying that divi-
dends will be $1,276,800 (= .60 × $2,128,000). Dividends per share will be $1.28
illustrates an intuitive or mathematical ap- (= $1,276,800/1,000,000). Given that g = .064, we calculate R from Equation 9.9 as follows:
$1.28
.192 = ______ + .064
plication in a step-by-step format. There is $10.00

enough detail in the explanations so stu-

A HEALTHY SENSE OF SKEPTICISM
dents don’t have to look elsewhere for It is important to emphasize that our approach merely estimates g; our approach does
not determine g precisely. We mentioned earlier that our estimate of g is based on a
additional information. number of assumptions. We assumed that the return on reinvestment of future retained

In Their Own Words

ROBERT C. HIGGINS ON SUSTAINABLE
GROWTH
Most financial officers know intuitively that it takes
money to make money. Rapid sales growth requires
increased assets in the form of accounts receivable,
inventory, and fixed plant, which, in turn, require money
to pay for assets. They also know that if their company
does not have the money when needed, it can literally
be what to do with all the cash that keeps piling up in
the till.
Bankers also find the sustainable growth equation
useful for explaining to financially inexperienced small
business owners and overly optimistic entrepreneurs
that, for the long-run viability of their business, it is nec-
essary to keep growth and profitability in proper
balance.
Finally, comparison of actual to sustainable growth

“In Their Own Words” Boxes

“grow broke.” The sustainable growth equation states
these intuitive truths explicitly.
Sustainable growth is often used by bankers and other
external analysts to assess a company’s creditworthiness.
They are aided in this exercise by several sophisticated
computer software packages that provide detailed analy-
ses of the company’s past financial performance, includ-
ing its annual sustainable growth rate.
Bankers use this information in several ways. Quick
comparison of a company’s actual growth rate to its sus-
tainable rate tells the banker what issues will be at the
top of management’s financial agenda. If actual growth
consistently exceeds sustainable growth, management’s
problem will be where to get the cash to finance growth.
The banker thus can anticipate interest in loan products.
Conversely, if sustainable growth consistently exceeds
actual, the banker had best be prepared to talk about
investment products because management’s problem will
rates helps a banker understand why a loan applicant
needs money and for how long the need might continue.
In one instance, a loan applicant requested $100,000 to
pay off several insistent suppliers and promised to repay
in a few months when he collected some accounts receiv- Located throughout the chapters, this unique se-
able that were coming due. A sustainable growth analysis
revealed that the firm had been growing at four to six
times its sustainable growth rate and that this pattern
ries consists of articles written by distinguished
was likely to continue in the foreseeable future. This
alerted the banker that impatient suppliers were only a
scholars or practitioners about key topics in the
symptom of the much more fundamental disease of
overly rapid growth, and that a $100,000 loan would text. Boxes include essays by Edward I. Altman,
likely prove to be only the down payment on a much
larger, multiyear commitment. Robert S. Hansen, Robert C. Higgins, Michael C.
SOURCE: Robert C. Higgins is the Marguerite Reimers Professor of
Finance, Emeritus, at the Foster School of Business at the University of Jensen, Merton Miller, and Jay R. Ritter.
Washington. He pioneered the use of sustainable growth as a tool for
financial analysis.

xiii
3.6 Some Caveats Regarding Financial
Planning Models
Financial planning models do not always ask the right questions. A primary reason is that
 CHAPTER 4 Discounted Cash Flow Valuation ■■■ 97

Spreadsheet Applications SPREADSHEET APPLICATIONS

Using a Spreadsheet for Time Value of Money Calculations

Now integrated into select chapters, Spread- More and more, businesspeople from many different areas (not only finance and accounting) rely on spread-
sheets to do all the different types of calculations that come up in the real world. In this section, we will
sheet Applications boxes reintroduce students show you how to use a spreadsheet to handle the various time value of money problems we present in this
chapter. We will use Microsoft Excel™, but the commands are similar for other types of software. We assume
to Excel, demonstrating how to set up spread- you are already familiar with basic spreadsheet operations.
As we have seen, you can solve for any one

sheets in order to analyze common financial of the following four potential unknowns: future
value, present value, the discount rate, or the num-
To Find Enter This Formula

ber of periods. The box at right lists formulas that Future value = FV (rate,nper,pmt,pv)
problems—a vital part of every business stu- can be used in Excel to solve for each input in the
Present value
Discount rate
= PV (rate,nper,pmt,fv)
= RATE (nper,pmt,pv,fv)
time value of money equation. Number of periods = NPER (rate,pmt,pv,fv)
dent’s education. (For even more spreadsheet In these formulas, pv and fv are present value
and future value, nper is the number of periods,

example problems, check out ExcelMaster and rate is the discount, or interest, rate.
Two things are a little tricky here. First, unlike a financial calculator, the spreadsheet requires that the rate
be entered as a decimal. Second, as with most financial calculators, you have to put a negative sign on
in Connect). either the present value or the future value to solve for the rate or the number of periods. For the same
reason, if you solve for a present value, the answer will have a negative sign unless you input a negative
22 ■■■ PART I Overview
future value. The same is true when you compute a future value.
To illustrate how you might use these formulas, we will go back to an example in the chapter. If you invest
the least liquid kind of assets. Tangible fixed assets include property, plant, and equipment. $25,000 at 12 percent per year, how long until you have $50,000? You might set up a spreadsheet like this:
Annual and
quarterly financial These assets do not convert to cash from normal business activity, and they are not usu-
A B C D E F G H
statements for ally used to pay expenses such as payroll.
1
most public U.S. Some fixed assets are intangible. Intangible assets have no physical existence but can be 2 Using a spreadsheet for time value of money calculations
corporations can be very valuable. Examples of intangible assets are the value of a trademark or the value of a pat- 3
found in the EDGAR
ent. The more liquid a firm’s assets, the less likely the firm is to experience problems meeting 4 If we invest $25,000 at 12 percent, how long until we have $50,000? We need to solve
database at 5 for the unknown number of periods, so we use the formula NPER(rate,pmt,pv,fv).
www.sec.gov. short-term obligations. The probability that a firm will avoid financial distress can be linked to
6
the firm’s liquidity. Unfortunately, liquid assets frequently have lower rates of return than fixed 7 Present value (pv): $25,000
assets; for example, cash generates no investment income. To the extent a firm invests in liquid 8 Future value (fv): $50,000
assets, it sacrifices an opportunity to invest in potentially more profitable investment vehicles. 9 Rate (rate): .12
10
11 Periods: 6.1162554
DEBT VERSUS EQUITY 12
13 The formula entered in cell B11 is =NPER(B9,0,-B7,B8); notice that pmt is zero and that pv
Liabilities are obligations of the firm that require a payout of cash within a stipulated period.
14 has a negative sign on it. Also notice that rate is entered as a decimal, not a percentage.
Many liabilities involve contractual obligations to repay a stated amount plus interest over
a period. Liabilities are debts and are frequently associated with fixed cash burdens, called
debt service, that put the firm in default of a contract if they are not paid. Stockholders’ equity
is a claim against the firm’s assets that is residual and not fixed. In general terms, when the EXAMPLE
firm borrows, it gives the bondholders first claim on the firm’s cash flow.1 Bondholders can 4.9 Waiting for Godot You’ve been saving up to buy the Godot Company. The total cost will be
sue the firm if the firm defaults on its bond contracts. This may lead the firm to declare $10 million. You currently have about $2.3 million. If you can earn 5 percent on your money,
itself bankrupt. Stockholders’ equity is the difference between assets and liabilities: how long will you have to wait? At 16 percent, how long must you wait?
At 5 percent, you’ll have to wait a long time. From the present value equation:
Assets − Liabilities ≡ Stockholders’ equity
$2.3 million = $10 million/1.05t
This is the stockholders’ share in the firm stated in accounting terms. The accounting 1.05t = 4.35
CHAPTER 25 Derivatives and Hedging Risk ■■■ 771
value of stockholders’ equity increases when retained earnings are added. This occurs t ≅ 30 years
when the firm retains part of its earnings instead of paying them out as dividends. At 16 percent, things are a little better. Verify for yourself that it will take about 10 years.
Moon Chemical. Because there is a crude oil futures contract for every month, selecting the
correct futures contract is not difficult. Many other commodities have only five contracts per
VALUE VERSUS COST
The home page year, frequently necessitating buying contracts one month away from the month of production.
for the Financial The accounting value of a firm’s assets is frequently referred to as the carrying value or
Explanatory Website Links
Accounting As mentioned earlier,
the book Moon
value Chemical
of the assets.is2 interested in hedging
Under generally the risk
accepted of fluctuating
accounting oil
principles (GAAP),
Standards Board
prices because it cannot pass any cost increases on to the consumer. Suppose, alternatively, 3
audited financial statements of firms in the United States carry assets at cost. The terms
(FASB) is that Moon Chemical was not selling petrochemicals on a fixed contract to the U.S. government.
These web links are specifically selected to ac-
www.fasb.org. carrying value and book value are misleading and cause many readers of financial state-
Instead, imagine that the petrochemicals were to be sold to private industry at currently prevail-
ments to believe the firm’s assets are recorded at true market values. Market value is the
ing prices. The price of petrochemicals should move directly with oil prices because oil is a
company text material and provide students and
price at which willing buyers and sellers would trade the assets. It would be only a coin-
major component of petrochemicals. Because cost increases are likely to be passed on to the
cidence if accounting value and market value were the same. In fact, management’s job
consumer, Moon Chemical would probably not want to hedge in this case. Instead, the firm is
is to create value for the firm that exceeds its cost.
instructors with a quick reference to additional
likely to choose Strategy 1, buying the oil as it is needed. If oil prices increase between April 1
and, say, September
ferent.
Many peopleChemical,
1, Moon use the balance
of course, sheet,
will but
findthethatinformation each become
its inputs have may wish to extract is dif-
quite information on the Internet.
costly. However, in aAcompetitive
banker maymarket,look atitsa revenues
balance sheet for evidence
are likely to rise, of
as accounting
well. liquidity and working
Strategy 2 is called a long hedge because one purchases a futures contract to reduce risk. promptness
capital, while a supplier also may note the size of accounts payable and the general
In other words,of one
payments.
takes aMany long users
positionof financial statements,
in the futures market.including
In general,managers and investors,
a firm institutes a want to
long hedge whenknowitthe value of the
is committed to firm,
a fixednot its cost.
sales price.This
Oneinformation is not found
class of situations involves onactual
the balance sheet.
written contracts with customers, such as the one Moon Chemical had with the U.S. government.
Alternatively, a firm may find that it cannot easily pass on costs to consumers or does not want
to pass on these
1 costs. For example, a group of students opened a small meat market called
Bondholders are investors in the firm’s debt. They are creditors of the firm. In this discussion, the term bondholder means the
What’s Your Beef nearas the
same thing University of Pennsylvania in the late 1970s.6 This was a time of
creditor.
2
volatile consumer prices,
Confusion oftenespecially
arises becausefood
manyprices.
financial Knowing
accounting that
terms their fellow
have the students
same meaning. Forwere par-
example, the following terms
usually refer to the same thing: assets minus liabilities, net worth, stockholders’ equity, owners’ equity, book equity, and equity
ticularly budget-conscious,
capitalization.
the owners vowed to keep food prices constant regardless of price
movements in3Generally,
either direction.
the U.S. GAAPTheyrequire
accomplished this byatpurchasing
assets to be carried futures
the lower of cost contracts
or market value. Ininmost
various
instances, cost is lower
agricultural commodities.
than market value. However, in some cases when a fair market value can be readily determined, the assets have their value
adjusted to the fair market value.

25.5 Interest Rate Futures Contracts

In this section, we consider interest rate futures contracts. Our examples deal with futures
contracts on Treasury bonds because of their high popularity. We first price Treasury
bonds and Treasury bond forward contracts. Differences between futures and forward
contracts are explored. Hedging examples are provided next.

PRICING OF TREASURY BONDS

As mentioned earlier in the text, a Treasury bond pays semiannual interest over its life.
In addition, the face value of the bond is paid at maturity. Consider a 20-year, 8 percent Numbered Equations
coupon bond that was issued on March 1. The first payment is to occur in six months—that
is, on September 1. The value of the bond can be determined as follows:
Pricing of Treasury Bond
Key equations are numbered and listed on the back
$40
PTB = ______
1 + R1 +
$40
________
2 +
$40
________ $40
+ ˙ ˙ ˙ + __________
$1,040
+ __________ (25.1) endsheets for easy reference.
(1 + R2) (1 + R3)3 (1 + R39)39 (1 + R40)40
Because an 8 percent coupon bond pays interest of $80 a year, the semiannual coupon
is $40. Principal and the semiannual coupon are both paid at maturity. As we mentioned
in a previous chapter, the price of the Treasury bond, PTB, is determined by discounting
each payment on the bond at the appropriate spot rate. Because the payments are semian-
nual, each spot rate is expressed in semiannual terms. That is, imagine a horizontal term
structure where the effective annual yield is 8 percent for all maturities. Because each
6
Ordinarily, an unusual firm name in this textbook is a tip-off that it is fictional. This, however, is a true story.

xiv
The end-of-chapter material reflects and builds upon the concepts learned from the chapter and study features.
790 ■■■ PART VI Options, Futures, and Corporate Finance

Summary and Conclusions Summary and Conclusions

1. Firms hedge to reduce risk. This chapter showed a number of hedging strategies.
2. A forward contract is an agreement by two parties to sell an item for cash at a later date.
The price is set at the time the agreement is signed. However, cash changes hands on the
The summary provides a quick review of key concepts
date of delivery. Forward contracts are generally not traded on organized exchanges.
3. Futures contracts are also agreements for future delivery. They have certain advantages,
such as liquidity, that forward contracts do not. An unusual feature of futures contracts
in the chapter.
is the mark-to-the-market convention. If the price of a futures contract falls on a particu-
lar day, every buyer of the contract must pay money to the clearinghouse. Every seller of
the contract receives money from the clearinghouse. Everything is reversed if the price
rises. The mark-to-the-market convention prevents defaults on futures contracts.
4. We divided hedges into two types: short hedges and long hedges. An individual or firm
Questions and Problems
that sells a futures contract to reduce risk is instituting a short hedge. Short hedges are
generally appropriate for holders of inventory. An individual or firm that buys a futures
contract to reduce risk is instituting a long hedge. Long hedges are typically used by firms Because solving problems is so critical to a student’s
with contracts to sell finished goods at a fixed price.
5. An interest rate futures contract employs a bond as the deliverable instrument. Because
of their popularity, we worked with Treasury bond futures contracts. We showed that
learning, new questions and problems have been
Treasury bond futures contracts can be priced using the same type of net present value
analysis that is used to price Treasury bonds themselves.
6. Many firms face interest rate risk. They can reduce this risk by hedging with interest rate
added and existing questions and problems have
futures contracts. As with other commodities, a short hedge involves the sale of a futures
contract. Firms that are committed to buying mortgages or other bonds are likely to institute been revised. All problems also have been thoroughly
short hedges. A long hedge involves the purchase of a futures contract. Firms that have
agreed to sell mortgages or other bonds at a fixed price are likely to institute long hedges.
7. Duration measures the average maturity of all the cash flows of a bond. Bonds with high reviewed and checked for accuracy.
duration have high price variability. Firms frequently try to match the duration of their
assets with the duration of their liabilities.
8. Swaps are agreements to exchange cash flows over time. The first major type is an inter-
Problems have been grouped according to level
est rate swap in which one pattern of coupon payments, say, fixed payments, is exchanged
for another, say, coupons that float with LIBOR. The second major type is a currency
swap, in which an agreement is struck to swap payments denominated in one currency
of difficulty with the levels listed in the margin: Basic,
124 ■■■ PART II Valuation and Capital Budgeting
CHAPTER 4 Discounted Cash Flow Valuation ■■■ 131
for payments in another currency over time.
Intermediate, and Challenge.
Well-known financial
18. Value
73. Present Interest
of aRates
Growing Perpetuity Whatwriter
is theAndrew Tobias
equation for argues that hevalue
the present can earn
of a 177
Additionally, one $10 we bottle ofhave
with a payment tried
fine Bordeaux per weekto
of C one periodmake from today the
He problems
percent per year buying wine by the case. Specifically, he assumes that he will consume
growing perpetuity
by C eachper period?
if the payments
for the next 12 weeks.
grow
can either pay $10
Concept Questions week or buy a case of 12 bottles today. If he buys the case, he receives a 10 percent

1. Hedging Strategies If a firm is selling futures contracts on lumber as a hedging strategy,

in the74.critical “concept”
A useful
Rule of 72discount and, rule
sumes the firstisbottle
discrete compounding
of thumb
by doing
chapters,
today. of
the “Rule
for the
so, earns
Do72.”
the time
you To
177 percent.
agree
usewith
such
it takes
the his
Assume
analysis?
Rule
as
an investment
of 72, Do youyou
those
he buystothe double
see a72
divide
wine with
on
and con-
problem
by thewith
his numbers?
rate to determine the number of periods it takes for a value today to double. For exam-
what must be true about the firm’s exposure to lumber prices?
2. Hedging Strategies If a firm is buying call options on pork belly futures as a hedging
value, risk,ple,19. and
if the rate iscapital
6 percent,
Calculating Number the structure,
Rule of 72
of Periods Onesays especially
it will
of your take 72/6
customers is = 12 yearschalleng-
delinquent to his
on double.
accounts
strategy, what must be true about the firm’s exposure to pork belly prices? This is approximately
payable balance. equal to the
You’ve actualagreed
mutually answerto of 11.90 years.
a repayment The Rule
schedule of 72
of $400 peralso
month.
3. Forwards and Futures What is the difference between a forward contract and a futures
contract? Why do you think that futures contracts are much more common? Are there any
ing and can interesting.
be applied
This is a balance
to determine
You will what rate
charge 1.1 percent
is $16,450, howfor
useful approximation long
perismonth
neededinterest
will rates
many it takeand
to double
for periods.
money
on the
the account
overduein abalance.
specifiedIf period.
to be rate
At what paid isoff?
the current
the Rule of
72 exact?
circumstances under which you might prefer to use forwards instead of futures? Explain.
4. Hedging Commodities Bubbling Crude Corporation, a large Texas oil producer, would
We provide
75. Rule of 69.3
answers
A corollary
toyouselected
the Rule and of
the Rule
problems
20. Calculating EAR Friendly’s Quick Loans, Inc., offers you “three for four or I knock
on your door.” This to means ofget72$3is today repay $4The
69.3. when Rule
inyourisAp-
youofget69.3 pay-
like to hedge against adverse movements in the price of oil because this is the firm’s check except
exactly correct in one for
week (or else).
rounding What’s
when ratestheareEAR Friendly’scontinuously.
compounded earns on thisProve lendingthebusi-
primary source of revenue. What should the firm do? Provide at least two reasons why it
pendix BRuleatof 69.3 the
ness?forIfend
paying?
you wereof
continuously bravethe
enoughbook.
compounded tointerest.
ask, what APR would Friendly’s say you were

INTERMEDIATE 21. Future Value What is the future value in 11 years of $1,000 invested in an account
(Questions 21–50) with an APR of 8.9 percent:
a. Compounded annually?
Excel Master It! Problems Excel Master It! Problem b. Compounded semiannually?
c. Compounded monthly?
d. Compounded continuously?
Excel Excel is a great tool for solving problems, but with many time value of money problems, you
e. Why does the future value increase as the compounding period shortens?
Included in the end-of-chapter material are prob- Master
coverage online
may still need to draw a time line. Consider a classic retirement problem. A friend is celebrat-
ing her birthday and wants
22. Simple to start
Interest versussaving for herInterest
Compound anticipated
Firstretirement.
Simple BankShepays
has5.3
thepercent
following
simple
years to retirement andon
interest retirement spending
its investment goals:If First Complex Bank pays interest on its accounts
accounts.
lems directly incorporating Excel, and new tips and compounded annually, what rate should the bank set if it wants to match First Simple
Bank over an investment horizon of 10 years?
Years until retirement 30
techniques taught in the chapter’s ExcelMaster 23. Calculating
To do
AmountAnnuities
to withdraw
this,toyou
You are year
each
will invest
planning to save for$90,000
retirement over the next 30 years.
$850 per month in a stock account and $350 per month
Years withdraw in retirement 20
in a Investment
bond account. The return of the stock account is expected to be 10 percent per
supplement. rate 8%
year, and the bond account will earn 6 percent per year. When you retire, you will
combine your money into an account with an annual return of 7 percent. How much
can you withdraw each month from your account assuming
Because your friend is planning ahead, the first withdrawal will not take place a 25-year withdrawal
until one
period?She wants to make equal annual deposits into her account for her retire-
year after she retires.

Excel Problems ment fund.24. Calculating Rates of Return Suppose an investment offers to quadruple your money in
a. If she 12 months
starts (don’t
making believe
these it). What
deposits rate year
in one of return
and per quarter
makes her are
lastyou being on
deposit offered?
the
25. sheCalculating
day Rates
retires, what must You’re
of Return
amount tryingannually
she deposit to choosetobetween
be abletwo different
to make the investments,
desired
both of which have
withdrawals in retirement? up-front costs of $65,000. Investment G returns $125,000 in 6 years.
Indicated by the Excel icon in the margin, these b. SupposeInvestment H returns
your friend $205,000a in
has inherited 10 years.
large sum of Which of these
money. investments
Rather than makinghas the higher
equal
annualreturn?
payments, she has decided to make one lump-sum deposit today to cover her
problems can be found at the end of almost all retirement
26. Growing
c. Suppose
needs.
laseryour
What amount
Perpetuities
eye friend’s
Markdoes
employer
surgery. His
she have
Weinstein
will will
technology contribute
to deposit
has been working
to the
be available
today?
on an advanced technology in
account
in the each He
near term. year as part his
anticipates
of the first annual cash
company’s flow from plan.
profit-sharing the technology
In addition, to beyour
$175,000,
friend received
expects two years from
a distribu-
chapters. Located in Connect Finance for Corpo- today.a Subsequent
tion from family trustannual cashyears
several flowsfrom
will grow
now. atWhat
3.8 percent
amount in must
perpetuity. What is the
she deposit
present
annually nowvalue of the
to be abletechnology
to make ifthe the desired
discount withdrawals
rate is 9.7 percent?
in retirement? The
rate Finance, 12e, Excel templates have been cre- details are:
27. Perpetuities A prestigious investment bank designed a new security that pays a
quarterly dividend of $2.25 in perpetuity. The first dividend occurs one quarter from

ated for each of these problems, where students today. What is the price of the security if the APR is 3.8 percent compounded
Employer’s annual contribution
quarterly?
Years until trust fund distribution
$ 1,500
20

can use the data in the problem to work out the Amount of trust fund distribution $25,000

solution using Excel skills.

132 ■■■ PART II Valuation and Capital Budgeting

End-of-Chapter Cases Mini Case THE MBA DECISION

Ben Bates graduated from college six years ago with a finance undergraduate degree. Although
he is satisfied with his current job, his goal is to become an investment banker. He feels that an
Located at the end of almost every chapter, these MBA degree would allow him to achieve this goal. After examining schools, he has narrowed
his choice to either Wilton University or Mount Perry College. Although internships are encour-
aged by both schools, to get class credit for the internship, no salary can be paid. Other than
mini cases focus on common company situations internships, neither school will allow its students to work while enrolled in its MBA program.
Ben currently works at the money management firm of Dewey and Louis. His annual salary
that embody important corporate finance topics. at the firm is $65,000 per year, and his salary is expected to increase at 3 percent per year until
retirement. He is currently 28 years old and expects to work for 40 more years. His current job
includes a fully paid health insurance plan, and his current average tax rate is 26 percent. Ben
Each case presents a new scenario, data, and a di- has a savings account with enough money to cover the entire cost of his MBA program.
The Ritter College of Business at Wilton University is one of the top MBA programs in
the country. The MBA degree requires two years of full-time enrollment at the university. The
lemma. Several questions at the end of each case annual tuition is $70,000, payable at the beginning of each school year. Books and other sup-
plies are estimated to cost $3,000 per year. Ben expects that after graduation from Wilton, he
require students to analyze and focus on all of the will receive a job offer for about $110,000 per year, with a $20,000 signing bonus. The salary
at this job will increase at 4 percent per year. Because of the higher salary, his average income
tax rate will increase to 31 percent.
material they learned in that chapter. The Bradley School of Business at Mount Perry College began its MBA program 16 years
ago. The Bradley School is smaller and less well known than the Ritter College. Bradley offers
an accelerated, one-year program, with a tuition cost of $85,000 to be paid upon matriculation.
Books and other supplies for the program are expected to cost $4,500. Ben thinks that he will
receive an offer of $92,000 per year upon graduation, with an $18,000 signing bonus. The
salary at this job will increase at 3.5 percent per year. His average tax rate at this level of xv
income will be 29 percent.
Both schools offer a health insurance plan that will cost $3,000 per year, payable at the
beginning of the year. Ben also estimates that room and board expenses will cost $2,000 more
per year at both schools than his current expenses, payable at the beginning of each year. The
appropriate discount rate is 4.7 percent.
1. How does Ben’s age affect his decision to get an MBA?
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Assurance of Learning is an important element of many accreditation standards. Corporate
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Instructor Resources
The Instructor Library in Connect contains all the necessary supplements—Instructor’s
Manual, Test Bank, Computerized Test Bank, and PowerPoint—all in one place. Go to
connect.mheducation.com to find:
●● Instructor’s Manual
Prepared by Steven D. Dolvin, Butler University
This is a great place to find new lecture ideas. The IM has three main sections. The
first section contains a chapter outline and other lecture materials. The annotated

xvi
 outline for each chapter includes lecture tips, real-world tips, ethics notes, suggested
PowerPoint slides, and, when appropriate, a video synopsis.
●● Test Bank
Prepared by Kay Johnson
Here’s a great format for a better testing process. The Test Bank has over 100 questions per
chapter that closely link with the text material and provide a variety of question formats
(multiple-choice questions/problems and essay questions) and levels of difficulty (basic,
intermediate, and challenge) to meet every instructor’s testing needs. Problems are detailed
enough to make them intuitive for students, and solutions are provided for the instructor.
●● TestGen
TestGen is a complete, state-of-the-art test generator and editing application software
that allows instructors to quickly and easily select test items from McGraw Hill’s
TestGen testbank content and to organize, edit, and customize the questions and
answers to rapidly generate paper tests. Questions can include stylized text, symbols,
graphics, and equations that are inserted directly into questions using built-in mathe-
matical templates. TestGen’s random generator provides the option to display different
text or calculated number values each time questions are used. With both quick-and-
simple test creation and flexible and robust editing tools, TestGen is a test generator
system for today’s educators.
●● PowerPoint Presentation System
Prepared by Steven D. Dolvin, Butler University
Customize our content for your course. This presentation has been thoroughly revised
to include more lecture-oriented slides, as well as exhibits and examples both from the
book and from outside sources. Applicable slides have web links that take you directly
to specific Internet sites, or a spreadsheet link to show an example in Excel. You also
can go to the Notes Page function for more tips on presenting the slides. If you already
have PowerPoint installed on your PC, you can edit, print, or rearrange the complete
presentation to meet your specific needs.
●● Excel Simulations
Expanded for this edition! With 180 Excel simulation questions now included in
Connect, RWJJ is the unparalleled leader in offering students the opportunity to prac-
tice using the Excel functions they will use throughout their careers in finance.
●● Corporate Finance Videos
New for this edition, brief and engaging conceptual videos (and accompanying ques-
tions) help students to master the building blocks of the Corporate Finance course.

STUDENT SUPPORT
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Each chapter’s slides follow the chapter topics and provide steps and explanations
showing how to solve key problems. Because each student learns differently, a quick
click on each slide will “talk through” its contents with you!

xvii
 ●● 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.
●● ExcelMaster
Developed by the authors for the RWJ franchise, this valuable and comprehensive
supplement provides a tutorial for students in using Excel in finance that is broken out
by chapter sections.

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FINGAME ONLINE 5.0 ISBN-10: 0-07-721988-0 / ISBN-13: 978-0-07-721988-8
By LeRoy Brooks, John Carroll University.
$15.00 when packaged with this text. In this comprehensive simulation game, students con-
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xviii
Acknowledgments

Andras Danis Abu Jalai Ronald M. Shapiro

Georgia Institute of Technology Suffolk University Rutgers University
Sugata Das Robert James Stephen V. Smith
Montana State University–Billings Boston College Drexel University
Lowell D’Souza Victoria Javine Mete Tepe
Northeastern University University of Alabama Virginia Tech
Eric Eller Roger Klee Gary P. Tripp
Loras College Cleveland State University Southern New Hampshire University
Melissa B. Frye Wendy Liu Emre Unlu
University of Central Florida University of Kentucky University of Nebraska
Melody J. Gunter Jeremy Marcq Kainan Wang
Florida State University Tufts University and Harvard University University of Toledo
Atul Gupta Narasimha Mohan Arthur J. Wilson
Bentley University Baldwin Wallace University George Washington University
Janet Hamilton Hongsong Neuhauser
Portland State University Elizabethtown College
John Hartman Francis Blaise Roncagli
University of California–Santa Barbara Cleveland State University

xix
Brief Contents

Part I
OVERVIEW
1 Introduction to Corporate Finance 1
2 Financial Statements and Cash Flow 20
3 Financial Statements Analysis and Financial Models 42

Part II
VALUATION AND CAPITAL BUDGETING
4 Discounted Cash Flow Valuation 85
5 Net Present Value and Other Investment Rules 133
6 Making Capital Investment Decisions 169
7 Risk Analysis, Real Options, and Capital Budgeting 205
8 Interest Rates and Bond Valuation 235
9 Stock Valuation 270

Part III
RISK
10 Lessons from Market History 299
11 Return, Risk, and the Capital Asset Pricing Model 328
12 An Alternative View of Risk and Return 371
13 Risk, Cost of Capital, and Valuation 393

Part IV
CAPITAL STRUCTURE AND DIVIDEND POLICY
14 Efficient Capital Markets and Behavioral Challenges 428
15 Long-Term Financing 468
16 Capital Structure 487
17 Capital Structure 519
18 Valuation and Capital Budgeting for the Levered Firm 551
19 Dividends and Other Payouts 573

xx
Part V
LONG-TERM FINANCING
20 Raising Capital 612
21 Leasing 649

Part VI
OPTIONS, FUTURES, AND CORPORATE FINANCE
22 Options and Corporate Finance 673
23 Options and Corporate Finance: Extensions and Applications 718
24 Warrants and Convertibles 742
25 Derivatives and Hedging Risk 763

Part VII
SHORT-TERM FINANCE
26 Short-Term Finance and Planning 795
27 Cash Management 825
28 Credit and Inventory Management 847

Part VIII
SPECIAL TOPICS
29 Mergers, Acquisitions, and Divestitures 876
30 Financial Distress 919
31 International Corporate Finance 935

Appendix A: Mathematical Tables 963

Appendix B: Solutions to Selected End-of-Chapter Problems 972
Appendix C: Using the HP 10B and TI BA II Plus
Financial Calculators 975
Glossary 979
Name Index 987
Subject Index 989

xxi
Contents

PART I Overview 2.3 Taxes

Corporate and personal Tax Rates
26
26
Chapter 1 Average versus Marginal Tax Rates 26
2.4 Net Working Capital 27
Introduction to Corporate Finance 1 2.5 Cash Flow of the Firm 28
1.1 What Is Corporate Finance? 1 2.6 The Accounting Statement of Cash Flows 31
The Balance Sheet Model of the Firm 1 Cash Flow from Operating Activities 31
The Financial Manager 3 Cash Flow from Investing Activities 32
1.2 The Corporate Firm 4 Cash Flow from Financing Activities 32
The Sole Proprietorship 4 2.7 Cash Flow Management 33
The Partnership 4 Summary and Conclusions 34
The Corporation 5 Concept Questions 34
A Corporation by Another Name . . . 7 Questions and Problems 35
1.3 The Importance of Cash Flows 8 Excel Master It! Problem 39
Identification of Cash Flows 8 Mini Case: Cash Flows at Warf
Timing of Cash Flows 9 Computers, Inc. 40
Risk of Cash Flows 10
1.4 The Goal of Financial Management 10
Possible Goals 10
Chapter 3
The Goal of the Financial Manager 11 Financial Statements Analysis
A More General Goal 12 and Financial Models 42
1.5 The Agency Problem and Control
3.1 Financial Statements Analysis 42
of the Corporation 12
Standardizing Statements 42
Agency Relationships 13
Common-Size Balance Sheets 43
Management Goals 13
Common-Size Income Statements 44
Do Managers Act in the Stockholders’
3.2 Ratio Analysis 46
Interests? 14
Short-Term Solvency or Liquidity Measures 47
Stakeholders 15
Long-Term Solvency Measures 48
1.6 Regulation 16
Asset Management or Turnover Measures 50
The Securities Act of 1933 and the
Profitability Measures 52
Securities Exchange Act of 1934 16
Market Value Measures 53
Sarbanes-Oxley 17
3.3 The DuPont Identity 56
Summary and Conclusions 18
A Closer Look at ROE 56
Concept Questions 18
Problems with Financial Statement Analysis 58
3.4 Financial Models 59
Chapter 2 A Simple Financial Planning Model 59
The Percentage of Sales Approach 61
Financial Statements and Cash Flow 20 3.5 External Financing and Growth 65
2.1 The Balance Sheet 20 The Relationship Between EFN
Liquidity 21 and Growth 66
Debt versus Equity 22 Financial Policy and Growth 68
Value versus Cost 22 A Note about Sustainable Growth
2.2 The Income Statement 23 Rate Calculations 72
Generally Accepted Accounting 3.6 Some Caveats Regarding Financial
Principles 24 Planning Models 73
Noncash Items 25 Summary and Conclusions 74
Time and Costs 25 Concept Questions 74

xxii
 Questions and Problems 76 Problems with the Payback Method 137
Excel Master It! Problem 81 Managerial Perspective 138
Mini Case: Ratios and Financial Planning Summary of Payback 139
at East Coast Yachts 82 5.3 The Discounted Payback Period Method 139
5.4 The Internal Rate of Return 139
5.5 Problems with the IRR Approach 143
PART II Valuation and Definition of Independent and Mutually
Exclusive Projects 143
Capital Budgeting Two General Problems Affecting Both
Independent and Mutually
Chapter 4 Exclusive Projects 143
Discounted Cash Flow Valuation 85 The Modified Internal Rate of
Return (MIRR) 146
4.1 Valuation: The One-Period Case 85
Problems Specific to Mutually
4.2 The Multiperiod Case 89
Exclusive Projects 148
Future Value and Compounding 89
Redeeming Qualities of IRR 153
The Power of Compounding: A Digression 92
A Test 153
Present Value and Discounting 93
5.6 The Profitability Index 153
Finding the Number of Periods 96
Calculation of Profitability Index 154
The Algebraic Formula 99
5.7 The Practice of Capital Budgeting 155
4.3 Compounding Periods 100
Summary and Conclusions 157
Distinction between Annual Percentage
Concept Questions 158
Rate and Effective Annual Rate 101
Questions and Problems 160
Compounding over Many Years 102
Excel Master It! Problem 167
Continuous Compounding 102
Mini Case: Bullock Gold Mining 168
4.4 Simplifications 104
Perpetuity 104
Growing Perpetuity 106 Chapter 6
Annuity 107
Growing Annuity 113
Making Capital Investment Decisions 169
4.5 Loan Amortization 114 6.1 Incremental Cash Flows: The Key
4.6 What Is a Firm Worth? 118 to Capital Budgeting 169
Summary and Conclusions 120 Cash Flows—Not Accounting Income 169
Concept Questions 121 Sunk Costs 170
Questions and Problems 121 Opportunity Costs 171
Excel Master It! Problem 131 Side Effects 171
Mini Case: The MBA Decision 132 Allocated Costs 172
Appendix 4A: Net Present Value: First 6.2 The Baldwin Company: An Example 172
Principles of Finance 132 An Analysis of the Project 175
Appendix 4B: Using Financial Calculators 132 Which Set of Books? 177
A Note about Net Working Capital 177
A Note about Depreciation 178
Chapter 5 Interest Expense 179
Net Present Value and Other 6.3 Alternative Definitions of Operating
Investment Rules 133 Cash Flow 179
The Top-Down Approach 180
5.1 Why Use Net Present Value? 133 The Bottom-Up Approach 180
5.2 The Payback Period Method 136 The Tax Shield Approach 181
Defining the Rule 136 Conclusion 182

xxiii
6.4 Some Special Cases of Discounted 8.2 Government and Corporate Bonds 245
Cash Flow Analysis 182 Government Bonds 245
Evaluating Cost-Cutting Proposals 182 Corporate Bonds 246
Setting the Bid Price 184 Bond Ratings 248
Investments of Unequal Lives: The 8.3 Bond Markets 249
Equivalent Annual Cost Method 186 How Bonds Are Bought and Sold 249
6.5 Inflation and Capital Budgeting 187 Bond Price Reporting 250
Interest Rates and Inflation 187 A Note on Bond Price Quotes 253
Cash Flow and Inflation 189 8.4 Inflation and Interest Rates 254
Discounting: Nominal or Real? 190 Real versus Nominal Rates 254
Summary and Conclusions 192 Inflation Risk and Inflation-Linked
Concept Questions 193 Bonds 255
Questions and Problems 194 The Fisher Effect 256
Excel Master It! Problems 203 8.5 Determinants of Bond Yields 258
Mini Case: Bethesda Mining Company 203 The Term Structure of Interest Rates 258
Bond Yields and the Yield Curve:
Putting It All Together 260
Chapter 7 Conclusion 262
Risk Analysis, Real Options, Summary and Conclusions 262
and Capital Budgeting 205 Concept Questions 262
Questions and Problems 263
7.1 Sensitivity Analysis, Scenario Analysis, Excel Master It! Problem 267
and Break-Even Analysis 205 Mini Case: Financing East Coast
Sensitivity Analysis and Scenario Analysis 206 Yachts’s Expansion Plans with
Break-Even Analysis 209 a Bond Issue 268
7.2 Monte Carlo Simulation 213
Step 1: Specify the Basic Model 213
Step 2: Specify a Distribution for
Chapter 9
Each Variable in the Model 214
Step 3: The Computer Draws One Stock Valuation 270
Outcome 216 9.1 The Present Value of Common Stocks 270
Step 4: Repeat the Procedure 217 Dividends versus Capital Gains 270
Step 5: Calculate NPV 217 Valuation of Different Types of Stocks 271
7.3 Real Options 218 9.2 Estimates of Parameters in
The Option to Expand 218 the Dividend Discount Model 275
The Option to Abandon 219 Where Does g Come From? 275
Timing Options 221 Where Does R Come From? 277
7.4 Decision Trees 222 A Healthy Sense of Skepticism 278
Summary and Conclusions 224 Dividends or Earnings: Which
Concept Questions 225 to Discount? 279
Questions and Problems 226 The No-Dividend Firm 279
Excel Master It! Problem 232 9.3 Comparables 280
Mini Case: Bunyan Lumber, LLC 233 Price-Earnings Ratio 280
Enterprise Value Ratios 282
Chapter 8 9.4 Valuing Stocks Using Free Cash Flows 284
9.5 The Stock Markets 285
Interest Rates and Bond Valuation 235 Dealers and Brokers 285
8.1 Bonds and Bond Valuation 235 Organization of the NYSE 286
Bond Features and Prices 235 Types of Orders 289
Bond Values and Yields 236 NASDAQ Operations 289
Interest Rate Risk 239 Stock Market Reporting 290
Finding the Yield to Maturity: More Trial Summary and Conclusions 291
and Error 241 Concept Questions 292
Zero Coupon Bonds 243 Questions and Problems 293

xxiv
 Excel Master It! Problem 296 11.6 Diversification 345
Mini Case: Stock Valuation The Anticipated and Unanticipated
at Ragan Engines 297 Components of News 345
Risk: Systematic and Unsystematic 346
The Essence of Diversification 347
PART III Risk The Effect of Diversification: Another
Lesson from Market History 348
Chapter 10 11.7 Riskless Borrowing and Lending 349
The Optimal Portfolio 351
Lessons from Market History 299
11.8 Market Equilibrium 353
10.1 Returns 299 Definition of the Market Equilibrium
Dollar Returns 299 Portfolio 353
Percentage Returns 301 Definition of Risk When Investors Hold
10.2 Holding Period Returns 303 the Market Portfolio 354
10.3 Return Statistics 309 The Formula for Beta 356
10.4 Average Stock Returns and A Test 357
Risk-Free Returns 310 11.9 Relationship between Risk and Expected
10.5 Risk Statistics 312 Return (CAPM) 357
Variance 312 Expected Return on the Market 357
Normal Distribution and Its Implications Expected Return on an Individual Security 358
for Standard Deviation 314 Summary and Conclusions 361
10.6 More on Average Returns 315 Concept Questions 361
Arithmetic versus Geometric Averages 315 Questions and Problems 362
Calculating Geometric Average Returns 315 Excel Master It! Problem 368
Arithmetic Average Return or Geometric Mini Case: A Job at East Coast
Average Return? 317 Yachts, Part 2 369
10.7 The U.S. Equity Risk Premium: Historical Appendix 11A: Is Beta Dead? 370
and International Perspectives 317
10.8 2008: A Year of Financial Crisis 320
Summary and Conclusions 321 Chapter 12
Concept Questions 322 An Alternative View of Risk
Questions and Problems 322 and Return 371
Excel Master It! Problem 325
Mini Case: A Job at East Coast Yachts 326 12.1 Systematic Risk and Betas 371
12.2 Portfolios and Factor Models 374
Portfolios and Diversification 377
Chapter 11 12.3 Betas, Arbitrage, and Expected Returns 379
Return, Risk, and the Capital The Linear Relationship 379
The Market Portfolio and the
Asset Pricing Model 328
Single Factor 380
11.1 Individual Securities 328 12.4 The Capital Asset Pricing Model
11.2 Expected Return, Variance, and the Arbitrage Pricing Theory 381
and Covariance 329 Differences in Pedagogy 381
Expected Return and Variance 329 Differences in Application 381
Covariance and Correlation 330 12.5 Empirical Approaches to Asset Pricing 383
11.3 The Return and Risk for Portfolios 334 Empirical Models 383
The Expected Return on a Portfolio 334 Style Portfolios 384
Variance and Standard Deviation Summary and Conclusions 385
of a Portfolio 335 Concept Questions 386
11.4 The Efficient Set for Two Assets 338 Questions and Problems 387
11.5 The Efficient Set for Many Securities 342 Excel Master It! Problem 391
Variance and Standard Deviation Mini Case: The Fama-French Multifactor
in a Portfolio of Many Assets 344 Model and Mutual Fund Returns 391

xxv
Chapter 13 Foundations of Market Efficiency 432
14.3 The Different Types of Efficiency 433
Risk, Cost of Capital, and Valuation 393 The Weak Form 433
13.1 The Cost of Capital 393 The Semistrong and Strong Forms 434
13.2 Estimating the Cost of Equity Capital Some Common Misconceptions about
with the CAPM 394 the Efficient Market Hypothesis 436
The Risk-Free Rate 397 14.4 The Evidence 437
Market Risk Premium 397 The Weak Form 437
13.3 Estimation of Beta 398 The Semistrong Form 438
Real-World Betas 399 The Strong Form 441
Stability of Beta 399 14.5 The Behavioral Challenge
Using an Industry Beta 401 to Market Efficiency 442
13.4 Determinants of Beta 402 Rationality 442
Cyclicality of Revenues 402 Independent Deviations from Rationality 444
Operating Leverage 402 Arbitrage 445
Financial Leverage and Beta 403 14.6 Empirical Challenges to Market
13.5 The Dividend Discount Model Approach 404 Efficiency 446
Comparison of DDM and CAPM 405 14.7 Reviewing the Differences 451
13.6 Cost of Capital for Divisions 14.8 Implications for Corporate Finance 453
and Projects 406 1. Accounting Choices, Financial Choices,
13.7 Cost of Fixed Income Securities 408 and Market Efficiency 453
Cost of Debt 408 2. The Timing Decision 454
Cost of Preferred Stock 409 3. Speculation and Efficient Markets 455
13.8 The Weighted Average Cost of Capital 410 4. Information in Market Prices 457
13.9 Valuation with WACC 411 Summary and Conclusions 459
Project Evaluation and the WACC 412 Concept Questions 460
Firm Valuation with the WACC 412 Questions and Problems 463
13.10 Estimating Eastman Chemical’s Mini Case: Your 401(k) Account at
Cost of Capital 415 East Coast Yachts 466
13.11 Flotation Costs and the Weighted
Average Cost of Capital 417
The Basic Approach 417 Chapter 15
Flotation Costs and NPV 418 Long-Term Financing 468
Internal Equity and Flotation Costs 419
15.1 Some Features of Common
Summary and Conclusions 420
and Preferred Stocks 468
Concept Questions 420
Common Stock Features 468
Questions and Problems 422
Preferred Stock Features 471
Mini Case: Cost of Capital for
15.2 Corporate Long-Term Debt 472
Swan Motors 426
Is It Debt or Equity? 473
Appendix 13A: Economic Value Added
Long-Term Debt: The Basics 473
and the Measurement of
The Indenture 475
Financial Performance 427
15.3 Some Different Types of Bonds 478
Floating-Rate Bonds 478
Other Types of Bonds 478
PART IV Capital Structure 15.4 Bank Loans 479
and Dividend Policy 15.5 International Bonds 480
15.6 Patterns of Financing 480
Chapter 14 15.7 Recent Trends in Capital Structure 482
Efficient Capital Markets Which Are Best: Book or Market
Values? 482
and Behavioral Challenges 428
Summary and Conclusions 483
14.1 Can Financing Decisions Create Value? 428 Concept Questions 484
14.2 A Description of Efficient Capital Markets 430 Questions and Problems 485

xxvi
Chapter 16 17.6 Shirking, Perquisites, and Bad Investments:
A Note on Agency Cost of Equity 533
Capital Structure 487 Effect of Agency Costs of Equity
16.1 The Capital Structure Question on Debt-Equity Financing 535
and the Pie Theory 487 Free Cash Flow 535
16.2 Maximizing Firm Value versus 17.7 The Pecking-Order Theory 536
Maximizing Stockholder Interests 488 Rules of the Pecking Order 537
16.3 Financial Leverage and Firm Value: Implications 538
An Example 490 17.8 Personal Taxes 539
Leverage and Returns to Shareholders 490 The Basics of Personal Taxes 539
The Choice between Debt and Equity 492 The Effect of Personal Taxes on
A Key Assumption 494 Capital Structure 539
16.4 Modigliani and Miller: Proposition II 17.9 How Firms Establish Capital
(No Taxes) 494 Structure 540
Risk to Equityholders Rises with Summary and Conclusions 545
Leverage 494 Concept Questions 546
Proposition II: Required Return to Questions and Problems 546
Equityholders Rises with Leverage 495 Mini Case: McKenzie Corporation’s
MM: An Interpretation 501 Capital Budgeting 549
16.5 Taxes 503 Appendix 17A: Some Useful Formulas
The Basic Insight 503 of Financial Structure 550
Present Value of the Tax Shield 505 Appendix 17B: T  he Miller Model and the
Value of the Levered Firm 506 Graduated Income Tax550
Expected Return and Leverage
under Corporate Taxes 508
The Weighted Average Cost of Capital, Chapter 18
WACC, and Corporate Taxes 509 Valuation and Capital Budgeting
Stock Price and Leverage under for the Levered Firm 551
Corporate Taxes 510
Summary and Conclusions 512 18.1 Adjusted Present Value Approach 551
Concept Questions 512 18.2 Flow to Equity Approach 553
Questions and Problems 513 Step 1: Calculating Levered Cash
Mini Case: Stephenson Real Estate Flow (LCF) 553
Recapitalization 518 Step 2: Calculating RS 554
Step 3: Valuation 554
18.3 Weighted Average Cost
Chapter 17 of Capital Method 554
18.4 A Comparison of the APV, FTE,
Capital Structure 519
and WACC Approaches 555
17.1 Costs of Financial Distress 519 A Suggested Guideline 556
Bankruptcy Risk or Bankruptcy Cost? 519 18.5 Valuation When the Discount Rate
17.2 Description of Financial Distress Costs 521 Must Be Estimated 558
Direct Costs of Financial Distress: Legal 18.6 APV Example 560
and Administrative Costs of Liquidation 18.7 Beta and Leverage 563
or Reorganization 521 The Project Is Not Scale Enhancing 565
Indirect Costs of Financial Distress 523 Summary and Conclusions 566
Agency Costs 524 Concept Questions 566
17.3 Can Costs of Debt Be Reduced? 527 Questions and Problems 567
Protective Covenants 527 Mini Case: The Leveraged Buyout
Consolidation of Debt 528 of Cheek Products, Inc. 571
17.4 Integration of Tax Effects and Financial Appendix 18A: The Adjusted Present Value
Distress Costs 529 Approach to Valuing
Pie Again 530 Leveraged Buyouts 572
17.5 Signaling 531

xxvii
Chapter 19 PART V Long‐Term
Dividends and Other Payouts 573 Financing
19.1 Different Types of Payouts 573
19.2 Standard Method of Cash Chapter 20
Dividend Payment 574 Raising Capital 612
19.3 The Benchmark Case: An Illustration
of the Irrelevance of Dividend Policy 576 20.1 Early-Stage Financing and
Current Policy: Dividends Set Equal Venture Capital 612
to Cash Flow 576 Venture Capital 613
Alternative Policy: Initial Dividend Stages of Financing 614
Is Greater Than Cash Flow 576 Some Venture Capital Realities 615
The Indifference Proposition 577 Venture Capital Investments and
Homemade Dividends 577 Economic Conditions 616
A Test 578 20.2 The Public Issue 616
Dividends and Investment Policy 579 Direct Listing 617
19.4 Repurchase of Stock 579 Crowdfunding 617
Dividend versus Repurchase: Conceptual Initial Coin Offerings (ICOs) 619
Example 581 20.3 Alternative Issue Methods 620
Dividends versus Repurchases: 20.4 The Cash Offer 621
Real-World Considerations 582 Investment Banks 623
19.5 Personal Taxes, Dividends, The Offering Price 625
and Stock Repurchases 583 Underpricing: A Possible Explanation 625
Firms without Sufficient Cash to Pay Evidence on Underpricing 627
a Dividend 583 The Partial Adjustment Phenomenon 628
Firms with Sufficient Cash to Pay 20.5 The Announcement of New Equity
a Dividend 584 and the Value of the Firm 629
Summary of Personal Taxes 586 20.6 The Cost of New Issues 630
19.6 Real-World Factors Favoring The Costs of Going Public: A Case
a High-Dividend Policy 587 Study 632
Desire for Current Income 587 20.7 Rights 634
Behavioral Finance 587 The Mechanics of a Rights Offering 634
Agency Costs 588 Subscription Price 634
Information Content of Dividends Number of Rights Needed to Purchase
and Dividend Signaling 589 a Share 635
19.7 The Clientele Effect: A Resolution Effect of Rights Offering on Price
of Real-World Factors? 591 of Stock 635
19.8 What We Know and Do Not Know Effects on Shareholders 636
about Dividend Policy 593 The Underwriting Arrangements 637
Corporate Dividends Are Substantial 593 20.8 The Rights Puzzle 638
Fewer Companies Pay Dividends 594 20.9 Dilution 639
Corporations Smooth Dividends 595 Dilution of Percentage Ownership 639
Some Survey Evidence about Dividends 597 Dilution of Stock Price 639
19.9 Putting It All Together 598 Dilution of Book Value 640
19.10 Stock Dividends and Stock Splits 600 Dilution of Earnings Per Share 641
Some Details about Stock Splits Conclusion 641
and Stock Dividends 600 20.10 Shelf Registration 641
Value of Stock Splits and Stock Dividends 602 20.11 Issuing Long-Term Debt 642
Reverse Splits 603 Summary and Conclusions 643
Summary and Conclusions 604 Concept Questions 643
Concept Questions 604 Questions and Problems 645
Questions and Problems 606 Mini Case: East Coast Yachts
Mini Case: Electronic Timing, Inc. 610 Goes Public 648

xxviii
Chapter 21 22.3 Put Options 675
The Value of a Put Option at Expiration 676
Leasing 649 22.4 Selling Options 677
21.1 Types of Leases 649 22.5 Option Quotes 678
The Basics 649 22.6 Combinations of Options 679
Operating Leases 650 22.7 Valuing Options 682
Financial Leases 650 Bounding the Value of a Call 683
21.2 Accounting and Leasing 651 The Factors Determining Call
21.3 Taxes, the IRS, and Leases 653 Option Values 684
21.4 The Cash Flows of Leasing 654 A Quick Discussion of Factors
A Note about Taxes 656 Determining Put Option Values 687
21.5 A Detour for Discounting and Debt 22.8 An Option Pricing Formula 687
Capacity with Corporate Taxes 656 A Two-State Option Model 688
Present Value of Riskless Cash Flows 656 The Black-Scholes Model 690
Optimal Debt Level and Riskless 22.9 Stocks and Bonds as Options 695
Cash Flows 656 The Firm Expressed in Terms
21.6 NPV Analysis of the Lease-versus-Buy of Call Options 696
Decision 658 The Firm Expressed in Terms
The Discount Rate 658 of Put Options 697
21.7 Debt Displacement and Lease Valuation 659 A Resolution of the Two Views 698
The Basic Concept of Debt A Note about Loan Guarantees 699
Displacement 659 22.10 Options and Corporate Decisions:
Optimal Debt Level in the Xomox Some Applications 700
Example 660 Mergers and Diversification 700
21.8 Does Leasing Ever Pay? The Base Options and Capital Budgeting 702
Case 662 22.11 Investment in Real Projects
21.9 Reasons for Leasing 663 and Options 704
Good Reasons for Leasing 663 Summary and Conclusions 707
Bad Reasons for Leasing 666 Concept Questions 707
21.10 Some Unanswered Questions 667 Questions and Problems 708
Are the Uses of Leases and Debt Excel Master It! Problem 715
Complementary? 667 Mini Case: Clissold Industries Options 716
Why Are Leases Offered by Both
Manufacturers and Third-Party Lessors? 667 Chapter 23
Why Are Some Assets Leased More
Than Others? 667 Options and Corporate Finance:
Summary and Conclusions 668 Extensions and Applications 718
Concept Questions 668 23.1 Executive Stock Options 718
Questions and Problems 669 Why Options? 718
Mini Case: The Decision to Lease or Valuing Executive Compensation 719
Buy at Warf Computers 672 23.2 Valuing a Start-Up 722
Appendix 21A: APV Approach to Leasing 672 23.3 More about the Binomial Model 725
Heating Oil 725
23.4 Shutdown and Reopening Decisions 731
PART VI Options, Futures, Valuing a Gold Mine 731
and Corporate Finance The Abandonment and Opening
Decisions 732
Chapter 22 Valuing the Simple Gold Mine 734
Summary and Conclusions 738
Options and Corporate Finance 673
Concept Questions 738
22.1 Options 673 Questions and Problems 739
22.2 Call Options 674 Mini Case: Exotic Cuisines’ Employee
The Value of a Call Option at Expiration 674 Stock Options 741

xxix
Chapter 24 Currency Swaps 786
Credit Default Swaps 787
Warrants and Convertibles 742 Exotics 787
24.1 Warrants 742 25.8 Actual Use of Derivatives 788
24.2 The Difference between Warrants Summary and Conclusions 790
and Call Options 743 Concept Questions 790
How the Firm Can Hurt Warrant Holders 746 Questions and Problems 792
24.3 Warrant Pricing and the Mini Case: Williamson Mortgage, Inc. 794
Black-Scholes Model 746
24.4 Convertible Bonds 747
24.5 The Value of Convertible Bonds 748 PART VII Short‐Term
Straight Bond Value 748
Conversion Value 749 Finance
Option Value 750
24.6 Reasons for Issuing Warrants
Chapter 26
and Convertibles 751 Short-Term Finance and Planning 795
Convertible Debt versus Straight Debt 751
26.1 Tracing Cash and Net Working Capital 796
Convertible Debt versus Common Stock 752
26.2 The Operating Cycle and the Cash Cycle 797
The “Free Lunch” Story 753
Defining the Operating and Cash Cycles 798
The “Expensive Lunch” Story 754
The Operating Cycle and the Firm’s
A Reconciliation 754
Organization Chart 799
24.7 Why Are Warrants and Convertibles
Calculating the Operating and
Issued? 754
Cash Cycles 800
Matching Cash Flows 754
Interpreting the Cash Cycle 803
Risk Synergy 755
A Look at Operating and Cash Cycles 803
Agency Costs 755
26.3 Some Aspects of Short-Term
Backdoor Equity 756
Financial Policy 804
24.8 Conversion Policy 756
The Size of the Firm’s Investment in
Summary and Conclusions 757
Current Assets 804
Concept Questions 758
Alternative Financing Policies for
Questions and Problems 759
Current Assets 807
Mini Case: S&S Air’s Convertible Bond 761
Which Is Best? 809
26.4 Cash Budgeting 810
Chapter 25 Cash Outflow 811
The Cash Balance 811
Derivatives and Hedging Risk 763 26.5 The Short-Term Financial Plan 812
25.1 Derivatives, Hedging, and Risk 763 Unsecured Loans 812
25.2 Forward Contracts 764 Secured Loans 812
25.3 Futures Contracts 765 Other Sources 813
25.4 Hedging 769 Summary and Conclusions 813
25.5 Interest Rate Futures Contracts 771 Concept Questions 814
Pricing of Treasury Bonds 771 Questions and Problems 814
Pricing of Forward Contracts 772 Excel Master It! Problem 822
Futures Contracts 773 Mini Case: Keafer Manufacturing
Hedging in Interest Rate Futures 774 Working Capital Management 823
25.6 Duration Hedging 778
The Case of Zero Coupon Bonds 778 Chapter 27
The Case of Two Bonds with the Same
Maturity but with Different Coupons 779 Cash Management 825
Duration 780 27.1 Reasons for Holding Cash 825
Matching Liabilities with Assets 782 The Speculative and Precautionary
25.7 Swaps Contracts 784 Motives 825
Interest Rate Swaps 785 The Transaction Motive 826

xxx
 Compensating Balances 826 28.5 Credit Analysis 857
Costs of Holding Cash 826 When Should Credit Be Granted? 857
Cash Management versus Liquidity Credit Information 859
Management 826 Credit Evaluation and Scoring 860
27.2 Understanding Float 827 28.6 Collection Policy 860
Disbursement Float 827 Monitoring Receivables 860
Collection Float and Net Float 828 Collection Effort 861
Float Management 829 28.7 Inventory Management 861
Electronic Data Interchange and The Financial Manager and
Check 21: The End of Float? 832 Inventory Policy 862
27.3 Cash Collection and Concentration 833 Inventory Types 862
Components of Collection Time 833 Inventory Costs 862
Cash Collection 834 28.8 Inventory Management Techniques 863
Lockboxes 834 The ABC Approach 863
Cash Concentration 835 The Economic Order Quantity Model 863
Accelerating Collections: An Example 836 Extensions to the EOQ Model 868
27.4 Managing Cash Disbursements 838 Managing Derived-Demand Inventories 868
Increasing Disbursement Float 838 Summary and Conclusions 870
Controlling Disbursements 839 Concept Questions 871
27.5 Investing Idle Cash 840 Questions and Problems 872
Temporary Cash Surpluses 840 Mini Case: Credit Policy at Braam
Characteristics of Short-Term Securities 841 Industries 875
Some Different Types of Money Appendix 28A: More about Credit Policy
Market Securities 841 Analysis875
Summary and Conclusions 842
Concept Questions 843
Questions and Problems 844
Mini Case: Cash Management
PART VIII Special Topics
at Richmond Corporation 846
Chapter 29
Appendix 27A: Determining the Target
Cash Balance 846 Mergers, Acquisitions, and
Appendix 27B: Adjustable Rate Preferred Divestitures 876
Stock, Auction Rate Preferred
29.1 The Basic Forms of Acquisitions 876
Stock, and Floating-Rate
Merger or Consolidation 876
Certificates of Deposit 846
Acquisition of Stock 877
Acquisition of Assets 877
Chapter 28 A Classification Scheme 878
A Note about Takeovers 878
Credit and Inventory Management 847
29.2 Synergy 879
28.1 Credit and Receivables 847 29.3 Sources of Synergy 880
Components of Credit Policy 848 Revenue Enhancement 880
The Cash Flows from Granting Credit 848 Cost Reduction 881
The Investment in Receivables 848 Tax Gains 883
28.2 Terms of the Sale 849 Reduced Capital Requirements 885
The Basic Form 849 29.4 Two Financial Side Effects
The Credit Period 849 of Acquisitions 886
Cash Discounts 851 Earnings Growth 886
Credit Instruments 852 Diversification 887
28.3 Analyzing Credit Policy 853 29.5 A Cost to Stockholders
Credit Policy Effects 853 from Reduction in Risk 888
Evaluating a Proposed Credit Policy 853 The Base Case 888
28.4 Optimal Credit Policy 855 Both Firms Have Debt 888
The Total Credit Cost Curve 856 How Can Shareholders Reduce Their
Organizing the Credit Function 857 Losses from the Coinsurance Effect? 890

xxxi
29.6 The NPV of a Merger 890 Chapter 31
Cash 890
Common Stock 892
International Corporate Finance 935
Cash versus Common Stock 893 31.1 Terminology 936
29.7 Friendly versus Hostile Takeovers 894 31.2 Foreign Exchange Markets
29.8 Defensive Tactics 896 and Exchange Rates 936
Deterring Takeovers before Being in Play 896 Exchange Rates 937
Deterring a Takeover after the Company 31.3 Purchasing Power Parity 942
Is in Play 897 Absolute Purchasing Power Parity 942
29.9 Have Mergers Added Value? 899 Relative Purchasing Power Parity 943
Returns to Bidders 901 31.4 Interest Rate Parity, Unbiased
Target Companies 902 Forward Rates, and the
The Managers versus the Stockholders 902 International Fisher Effect 945
29.10 The Tax Forms of Acquisitions 904 Covered Interest Arbitrage 945
29.11 Accounting for Acquisitions 906 Interest Rate Parity 946
29.12 Going Private and Leveraged Buyouts 907 Forward Rates and Future Spot Rates 947
29.13 Divestitures 908 Putting It All Together 948
Sale 908 31.5 International Capital Budgeting 949
Spin-Off 908 Method 1: The Home Currency Approach 950
Carve-Out 909 Method 2: The Foreign Currency
Tracking Stocks 909 Approach 951
Summary and Conclusions 910 Unremitted Cash Flows 951
Concept Questions 910 The Cost of Capital for International
Questions and Problems 911 Firms 952
Mini Case: The Birdie Golf-Hybrid 31.6 Exchange Rate Risk 952
Golf Merger 917 Short-Term Exposure 952
Long-Term Exposure 953
Translation Exposure 954
Chapter 30 Managing Exchange Rate Risk 955
Financial Distress 919 31.7 Political Risk 955
The Tax Cuts and Jobs Act of 2017 955
30.1 What Is Financial Distress? 919
Managing Political Risk 956
30.2 What Happens in Financial Distress? 921
Summary and Conclusions 957
30.3 Bankruptcy Liquidation and
Concept Questions 957
Reorganization 923
Questions and Problems 959
Bankruptcy Liquidation 923
Excel Master It! Problem 961
Bankruptcy Reorganization 925
Mini Case: East Coast Yachts Goes
30.4 Private Workout or Bankruptcy:
International 962
Which Is Best? 928
The Marginal Firm 929
Holdouts 929
Appendix A: Mathematical Tables 963
Complexity 929
Appendix B: Solutions to Selected
Lack of Information 929
End-of-Chapter Problems 972
30.5 Prepackaged Bankruptcy 929
Appendix C: Using the HP 10B and TI BA II Plus
30.6 Predicting Corporate Bankruptcy:
Financial Calculators 975
The Z-Score Model 931
Glossary 979
Summary and Conclusions 932
Name Index 987
Concept Questions 933
Subject Index 989
Questions and Problems 933

xxxii
 1 PART I: OVERVIEW

Introduction to
Corporate Finance
In 2009, Travis Kalanick and Garrett Camp started the
ride service app Uber. Uber shot out of the gate, complet-
ing more than five billion rides by the middle of 2017.
Even though Uber was losing more than $100 million per
quarter, its market value reached $70 billion, with
Kalanick’s personal wealth exceeding $6 billion. Unfortu-
nately, Kalanick was accused of knowing about sexual
harassment in the company and doing nothing to resolve
the problem. Then, he was videotaped berating an Uber
driver. As a result, he was forced to step down as CEO
of the company in June 2017, although he remained the
by a major shareholder for fraud, breach of contract, and
breach of fiduciary responsibility.
Understanding Kalanick’s journey from the founder
of a ride-sharing app, to corporate executive, and finally
to embattled board chair takes us into issues involving
the corporate form of organization, corporate goals, and
corporate control—all of which we discuss in this chapter.
And if you are willing to share the ride with us, you’re
going to learn an uber-lot as you read.
Please visit us at rwjcorporatefinance.blogspot.com

chair of the company’s board of directors. And, reminis- for the latest developments in the world of corporate

cent of a runaway car, in August 2017, Kalanick was sued finance.

1.1 What Is Corporate Finance?

Suppose you decide to start a firm to make tennis balls. To do this you hire managers to buy
raw materials and assemble a workforce that will produce and sell finished tennis balls. In
the language of finance, you make an investment in assets such as inventory, machinery, land,
and labor. The amount of cash you invest in assets must be matched by an equal amount of
cash raised by financing. When you begin to sell tennis balls, your firm will generate cash.
This is the basis of value creation. The purpose of the firm is to create value for you, the
owner. The value is reflected in the framework of the simple balance sheet model of the firm.

THE BALANCE SHEET MODEL OF THE FIRM

Suppose we take a financial snapshot of the firm and its activities at a single point in
time. Figure 1.1 shows a graphic conceptualization of the balance sheet and it will help
introduce you to corporate finance.
The assets of the firm are on the left side of the balance sheet. These assets can be
thought of as current and fixed. Fixed assets are those that will last a long time, like

1
2  ■■■  PART I Overview

Figure 1.1
The Balance Sheet
Model of the Firm
Net Current liabilities
working
Current assets capital

Long-term debt

Fixed assets

1. Tangible fixed
assets
2. Intangible fixed Shareholders’ equity
assets

Total Value of Assets Total Value of the Firm

to Investors

buildings. Some fixed assets are tangible, such as machinery and equipment. Other fixed
assets are intangible, including patents and trademarks. The other category of assets, cur-
rent assets, comprises those that have short lives, such as inventory. The tennis balls that
your firm has made, but not yet sold, are part of its inventory. Unless you have overpro-
duced, they will leave the firm shortly.
Before a company can invest in an asset, it first must obtain financing, which means
that it must raise the money to pay for the investment. The forms of financing are repre-
sented on the right side of the balance sheet. A firm will issue (sell) pieces of paper called
debt (loan agreements) or equity shares (stock certificates). Both assets and liabilities can
be classified as long-lived or short-lived. A short-term debt is called a current liability.
Short-term debt represents loans and other obligations that must be repaid within one
year. Long-term debt is debt that does not have to be repaid within one year. Sharehold-
ers’ equity represents the difference between the value of the assets and the debt of the
firm. In this sense, it is a residual claim on the firm’s assets.
From the balance sheet model of the firm, it is easy to see why finance can be thought
of as the study of the following three questions:
1. In what long-lived assets should the firm invest? This question concerns the left side
of the balance sheet. Of course, the types and proportions of assets the firm needs
tend to be set by the nature of the business. We use the term capital budgeting to
describe the process of making and managing expenditures on long-lived assets.
2. How can the firm raise cash for required capital expenditures? This question con-
cerns the right side of the balance sheet. The answer to this question involves the
firm’s capital structure, which represents the proportions of the firm’s financing
from current and long-term debt and equity.
3. How should short-term operating cash flows be managed? This question concerns
the upper portion of the balance sheet. There is often a mismatch between the
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 DANCE ON STILTS AT THE GIRLS’ UNYAGO, NIUCHI

Newala, too, suffers from the distance of its water-supply—at least

the Newala of to-day does; there was once another Newala in a lovely
valley at the foot of the plateau. I visited it and found scarcely a trace
of houses, only a Christian cemetery, with the graves of several
missionaries and their converts, remaining as a monument of its
former glories. But the surroundings are wonderfully beautiful. A
thick grove of splendid mango-trees closes in the weather-worn
crosses and headstones; behind them, combining the useful and the
agreeable, is a whole plantation of lemon-trees covered with ripe
fruit; not the small African kind, but a much larger and also juicier
imported variety, which drops into the hands of the passing traveller,
without calling for any exertion on his part. Old Newala is now under
the jurisdiction of the native pastor, Daudi, at Chingulungulu, who,
as I am on very friendly terms with him, allows me, as a matter of
course, the use of this lemon-grove during my stay at Newala.
 FEET MUTILATED BY THE RAVAGES OF THE “JIGGER”
(Sarcopsylla penetrans)

The water-supply of New Newala is in the bottom of the valley,

some 1,600 feet lower down. The way is not only long and fatiguing,
but the water, when we get it, is thoroughly bad. We are suffering not
only from this, but from the fact that the arrangements at Newala are
nothing short of luxurious. We have a separate kitchen—a hut built
against the boma palisade on the right of the baraza, the interior of
which is not visible from our usual position. Our two cooks were not
long in finding this out, and they consequently do—or rather neglect
to do—what they please. In any case they do not seem to be very
particular about the boiling of our drinking-water—at least I can
attribute to no other cause certain attacks of a dysenteric nature,
from which both Knudsen and I have suffered for some time. If a
man like Omari has to be left unwatched for a moment, he is capable
of anything. Besides this complaint, we are inconvenienced by the
state of our nails, which have become as hard as glass, and crack on
the slightest provocation, and I have the additional infliction of
pimples all over me. As if all this were not enough, we have also, for
the last week been waging war against the jigger, who has found his
Eldorado in the hot sand of the Makonde plateau. Our men are seen
all day long—whenever their chronic colds and the dysentery likewise
raging among them permit—occupied in removing this scourge of
Africa from their feet and trying to prevent the disastrous
consequences of its presence. It is quite common to see natives of
this place with one or two toes missing; many have lost all their toes,
or even the whole front part of the foot, so that a well-formed leg
ends in a shapeless stump. These ravages are caused by the female of
Sarcopsylla penetrans, which bores its way under the skin and there
develops an egg-sac the size of a pea. In all books on the subject, it is
stated that one’s attention is called to the presence of this parasite by
an intolerable itching. This agrees very well with my experience, so
far as the softer parts of the sole, the spaces between and under the
toes, and the side of the foot are concerned, but if the creature
penetrates through the harder parts of the heel or ball of the foot, it
may escape even the most careful search till it has reached maturity.
Then there is no time to be lost, if the horrible ulceration, of which
we see cases by the dozen every day, is to be prevented. It is much
easier, by the way, to discover the insect on the white skin of a
European than on that of a native, on which the dark speck scarcely
shows. The four or five jiggers which, in spite of the fact that I
constantly wore high laced boots, chose my feet to settle in, were
taken out for me by the all-accomplished Knudsen, after which I
thought it advisable to wash out the cavities with corrosive
sublimate. The natives have a different sort of disinfectant—they fill
the hole with scraped roots. In a tiny Makua village on the slope of
the plateau south of Newala, we saw an old woman who had filled all
the spaces under her toe-nails with powdered roots by way of
prophylactic treatment. What will be the result, if any, who can say?
The rest of the many trifling ills which trouble our existence are
really more comic than serious. In the absence of anything else to
smoke, Knudsen and I at last opened a box of cigars procured from
the Indian store-keeper at Lindi, and tried them, with the most
distressing results. Whether they contain opium or some other
narcotic, neither of us can say, but after the tenth puff we were both
“off,” three-quarters stupefied and unspeakably wretched. Slowly we
recovered—and what happened next? Half-an-hour later we were
once more smoking these poisonous concoctions—so insatiable is the
craving for tobacco in the tropics.
Even my present attacks of fever scarcely deserve to be taken
seriously. I have had no less than three here at Newala, all of which
have run their course in an incredibly short time. In the early
afternoon, I am busy with my old natives, asking questions and
making notes. The strong midday coffee has stimulated my spirits to
an extraordinary degree, the brain is active and vigorous, and work
progresses rapidly, while a pleasant warmth pervades the whole
body. Suddenly this gives place to a violent chill, forcing me to put on
my overcoat, though it is only half-past three and the afternoon sun
is at its hottest. Now the brain no longer works with such acuteness
and logical precision; more especially does it fail me in trying to
establish the syntax of the difficult Makua language on which I have
ventured, as if I had not enough to do without it. Under the
circumstances it seems advisable to take my temperature, and I do
so, to save trouble, without leaving my seat, and while going on with
my work. On examination, I find it to be 101·48°. My tutors are
abruptly dismissed and my bed set up in the baraza; a few minutes
later I am in it and treating myself internally with hot water and
lemon-juice.
Three hours later, the thermometer marks nearly 104°, and I make
them carry me back into the tent, bed and all, as I am now perspiring
heavily, and exposure to the cold wind just beginning to blow might
mean a fatal chill. I lie still for a little while, and then find, to my
great relief, that the temperature is not rising, but rather falling. This
is about 7.30 p.m. At 8 p.m. I find, to my unbounded astonishment,
that it has fallen below 98·6°, and I feel perfectly well. I read for an
hour or two, and could very well enjoy a smoke, if I had the
wherewithal—Indian cigars being out of the question.
Having no medical training, I am at a loss to account for this state
of things. It is impossible that these transitory attacks of high fever
should be malarial; it seems more probable that they are due to a
kind of sunstroke. On consulting my note-book, I become more and
more inclined to think this is the case, for these attacks regularly
follow extreme fatigue and long exposure to strong sunshine. They at
least have the advantage of being only short interruptions to my
work, as on the following morning I am always quite fresh and fit.
My treasure of a cook is suffering from an enormous hydrocele which
makes it difficult for him to get up, and Moritz is obliged to keep in
the dark on account of his inflamed eyes. Knudsen’s cook, a raw boy
from somewhere in the bush, knows still less of cooking than Omari;
consequently Nils Knudsen himself has been promoted to the vacant
post. Finding that we had come to the end of our supplies, he began
by sending to Chingulungulu for the four sucking-pigs which we had
bought from Matola and temporarily left in his charge; and when
they came up, neatly packed in a large crate, he callously slaughtered
the biggest of them. The first joint we were thoughtless enough to
entrust for roasting to Knudsen’s mshenzi cook, and it was
consequently uneatable; but we made the rest of the animal into a
jelly which we ate with great relish after weeks of underfeeding,
consuming incredible helpings of it at both midday and evening
meals. The only drawback is a certain want of variety in the tinned
vegetables. Dr. Jäger, to whom the Geographical Commission
entrusted the provisioning of the expeditions—mine as well as his
own—because he had more time on his hands than the rest of us,
seems to have laid in a huge stock of Teltow turnips,[46] an article of
food which is all very well for occasional use, but which quickly palls
when set before one every day; and we seem to have no other tins
left. There is no help for it—we must put up with the turnips; but I
am certain that, once I am home again, I shall not touch them for ten
years to come.
Amid all these minor evils, which, after all, go to make up the
genuine flavour of Africa, there is at least one cheering touch:
Knudsen has, with the dexterity of a skilled mechanic, repaired my 9
× 12 cm. camera, at least so far that I can use it with a little care.
How, in the absence of finger-nails, he was able to accomplish such a
ticklish piece of work, having no tool but a clumsy screw-driver for
taking to pieces and putting together again the complicated
mechanism of the instantaneous shutter, is still a mystery to me; but
he did it successfully. The loss of his finger-nails shows him in a light
contrasting curiously enough with the intelligence evinced by the
above operation; though, after all, it is scarcely surprising after his
ten years’ residence in the bush. One day, at Lindi, he had occasion
to wash a dog, which must have been in need of very thorough
cleansing, for the bottle handed to our friend for the purpose had an
extremely strong smell. Having performed his task in the most
conscientious manner, he perceived with some surprise that the dog
did not appear much the better for it, and was further surprised by
finding his own nails ulcerating away in the course of the next few
days. “How was I to know that carbolic acid has to be diluted?” he
mutters indignantly, from time to time, with a troubled gaze at his
mutilated finger-tips.
 Since we came to Newala we have been making excursions in all
directions through the surrounding country, in accordance with old
habit, and also because the akida Sefu did not get together the tribal
elders from whom I wanted information so speedily as he had
promised. There is, however, no harm done, as, even if seen only
from the outside, the country and people are interesting enough.
The Makonde plateau is like a large rectangular table rounded off
at the corners. Measured from the Indian Ocean to Newala, it is
about seventy-five miles long, and between the Rovuma and the
Lukuledi it averages fifty miles in breadth, so that its superficial area
is about two-thirds of that of the kingdom of Saxony. The surface,
however, is not level, but uniformly inclined from its south-western
edge to the ocean. From the upper edge, on which Newala lies, the
eye ranges for many miles east and north-east, without encountering
any obstacle, over the Makonde bush. It is a green sea, from which
here and there thick clouds of smoke rise, to show that it, too, is
inhabited by men who carry on their tillage like so many other
primitive peoples, by cutting down and burning the bush, and
manuring with the ashes. Even in the radiant light of a tropical day
such a fire is a grand sight.
Much less effective is the impression produced just now by the
great western plain as seen from the edge of the plateau. As often as
time permits, I stroll along this edge, sometimes in one direction,
sometimes in another, in the hope of finding the air clear enough to
let me enjoy the view; but I have always been disappointed.
Wherever one looks, clouds of smoke rise from the burning bush,
and the air is full of smoke and vapour. It is a pity, for under more
favourable circumstances the panorama of the whole country up to
the distant Majeje hills must be truly magnificent. It is of little use
taking photographs now, and an outline sketch gives a very poor idea
of the scenery. In one of these excursions I went out of my way to
make a personal attempt on the Makonde bush. The present edge of
the plateau is the result of a far-reaching process of destruction
through erosion and denudation. The Makonde strata are
everywhere cut into by ravines, which, though short, are hundreds of
yards in depth. In consequence of the loose stratification of these
beds, not only are the walls of these ravines nearly vertical, but their
upper end is closed by an equally steep escarpment, so that the
western edge of the Makonde plateau is hemmed in by a series of
deep, basin-like valleys. In order to get from one side of such a ravine
to the other, I cut my way through the bush with a dozen of my men.
It was a very open part, with more grass than scrub, but even so the
short stretch of less than two hundred yards was very hard work; at
the end of it the men’s calicoes were in rags and they themselves
bleeding from hundreds of scratches, while even our strong khaki
suits had not escaped scatheless.

NATIVE PATH THROUGH THE MAKONDE BUSH, NEAR

MAHUTA

I see increasing reason to believe that the view formed some time
back as to the origin of the Makonde bush is the correct one. I have
no doubt that it is not a natural product, but the result of human
occupation. Those parts of the high country where man—as a very
slight amount of practice enables the eye to perceive at once—has not
yet penetrated with axe and hoe, are still occupied by a splendid
timber forest quite able to sustain a comparison with our mixed
forests in Germany. But wherever man has once built his hut or tilled
his field, this horrible bush springs up. Every phase of this process
may be seen in the course of a couple of hours’ walk along the main
road. From the bush to right or left, one hears the sound of the axe—
not from one spot only, but from several directions at once. A few
steps further on, we can see what is taking place. The brush has been
cut down and piled up in heaps to the height of a yard or more,
between which the trunks of the large trees stand up like the last
pillars of a magnificent ruined building. These, too, present a
melancholy spectacle: the destructive Makonde have ringed them—
cut a broad strip of bark all round to ensure their dying off—and also
piled up pyramids of brush round them. Father and son, mother and
son-in-law, are chopping away perseveringly in the background—too
busy, almost, to look round at the white stranger, who usually excites
so much interest. If you pass by the same place a week later, the piles
of brushwood have disappeared and a thick layer of ashes has taken
the place of the green forest. The large trees stretch their
smouldering trunks and branches in dumb accusation to heaven—if
they have not already fallen and been more or less reduced to ashes,
perhaps only showing as a white stripe on the dark ground.
This work of destruction is carried out by the Makonde alike on the
virgin forest and on the bush which has sprung up on sites already
cultivated and deserted. In the second case they are saved the trouble
of burning the large trees, these being entirely absent in the
secondary bush.
After burning this piece of forest ground and loosening it with the
hoe, the native sows his corn and plants his vegetables. All over the
country, he goes in for bed-culture, which requires, and, in fact,
receives, the most careful attention. Weeds are nowhere tolerated in
the south of German East Africa. The crops may fail on the plains,
where droughts are frequent, but never on the plateau with its
abundant rains and heavy dews. Its fortunate inhabitants even have
the satisfaction of seeing the proud Wayao and Wamakua working
for them as labourers, driven by hunger to serve where they were
accustomed to rule.
But the light, sandy soil is soon exhausted, and would yield no
harvest the second year if cultivated twice running. This fact has
been familiar to the native for ages; consequently he provides in
time, and, while his crop is growing, prepares the next plot with axe
and firebrand. Next year he plants this with his various crops and
lets the first piece lie fallow. For a short time it remains waste and
desolate; then nature steps in to repair the destruction wrought by
man; a thousand new growths spring out of the exhausted soil, and
even the old stumps put forth fresh shoots. Next year the new growth
is up to one’s knees, and in a few years more it is that terrible,
impenetrable bush, which maintains its position till the black
occupier of the land has made the round of all the available sites and
come back to his starting point.
The Makonde are, body and soul, so to speak, one with this bush.
According to my Yao informants, indeed, their name means nothing
else but “bush people.” Their own tradition says that they have been
settled up here for a very long time, but to my surprise they laid great
stress on an original immigration. Their old homes were in the
south-east, near Mikindani and the mouth of the Rovuma, whence
their peaceful forefathers were driven by the continual raids of the
Sakalavas from Madagascar and the warlike Shirazis[47] of the coast,
to take refuge on the almost inaccessible plateau. I have studied
African ethnology for twenty years, but the fact that changes of
population in this apparently quiet and peaceable corner of the earth
could have been occasioned by outside enterprises taking place on
the high seas, was completely new to me. It is, no doubt, however,
correct.
The charming tribal legend of the Makonde—besides informing us
of other interesting matters—explains why they have to live in the
thickest of the bush and a long way from the edge of the plateau,
instead of making their permanent homes beside the purling brooks
and springs of the low country.
“The place where the tribe originated is Mahuta, on the southern
side of the plateau towards the Rovuma, where of old time there was
nothing but thick bush. Out of this bush came a man who never
washed himself or shaved his head, and who ate and drank but little.
He went out and made a human figure from the wood of a tree
growing in the open country, which he took home to his abode in the
bush and there set it upright. In the night this image came to life and
was a woman. The man and woman went down together to the
Rovuma to wash themselves. Here the woman gave birth to a still-
born child. They left that place and passed over the high land into the
valley of the Mbemkuru, where the woman had another child, which
was also born dead. Then they returned to the high bush country of
Mahuta, where the third child was born, which lived and grew up. In
course of time, the couple had many more children, and called
themselves Wamatanda. These were the ancestral stock of the
Makonde, also called Wamakonde,[48] i.e., aborigines. Their
forefather, the man from the bush, gave his children the command to
bury their dead upright, in memory of the mother of their race who
was cut out of wood and awoke to life when standing upright. He also
warned them against settling in the valleys and near large streams,
for sickness and death dwelt there. They were to make it a rule to
have their huts at least an hour’s walk from the nearest watering-
place; then their children would thrive and escape illness.”
The explanation of the name Makonde given by my informants is
somewhat different from that contained in the above legend, which I
extract from a little book (small, but packed with information), by
Pater Adams, entitled Lindi und sein Hinterland. Otherwise, my
results agree exactly with the statements of the legend. Washing?
Hapana—there is no such thing. Why should they do so? As it is, the
supply of water scarcely suffices for cooking and drinking; other
people do not wash, so why should the Makonde distinguish himself
by such needless eccentricity? As for shaving the head, the short,
woolly crop scarcely needs it,[49] so the second ancestral precept is
likewise easy enough to follow. Beyond this, however, there is
nothing ridiculous in the ancestor’s advice. I have obtained from
various local artists a fairly large number of figures carved in wood,
ranging from fifteen to twenty-three inches in height, and
representing women belonging to the great group of the Mavia,
Makonde, and Matambwe tribes. The carving is remarkably well
done and renders the female type with great accuracy, especially the
keloid ornamentation, to be described later on. As to the object and
meaning of their works the sculptors either could or (more probably)
would tell me nothing, and I was forced to content myself with the
scanty information vouchsafed by one man, who said that the figures
were merely intended to represent the nembo—the artificial
deformations of pelele, ear-discs, and keloids. The legend recorded
by Pater Adams places these figures in a new light. They must surely
be more than mere dolls; and we may even venture to assume that
they are—though the majority of present-day Makonde are probably
unaware of the fact—representations of the tribal ancestress.
 The references in the legend to the descent from Mahuta to the
Rovuma, and to a journey across the highlands into the Mbekuru
valley, undoubtedly indicate the previous history of the tribe, the
travels of the ancestral pair typifying the migrations of their
descendants. The descent to the neighbouring Rovuma valley, with
its extraordinary fertility and great abundance of game, is intelligible
at a glance—but the crossing of the Lukuledi depression, the ascent
to the Rondo Plateau and the descent to the Mbemkuru, also lie
within the bounds of probability, for all these districts have exactly
the same character as the extreme south. Now, however, comes a
point of especial interest for our bacteriological age. The primitive
Makonde did not enjoy their lives in the marshy river-valleys.
Disease raged among them, and many died. It was only after they
had returned to their original home near Mahuta, that the health
conditions of these people improved. We are very apt to think of the
African as a stupid person whose ignorance of nature is only equalled
by his fear of it, and who looks on all mishaps as caused by evil
spirits and malignant natural powers. It is much more correct to
assume in this case that the people very early learnt to distinguish
districts infested with malaria from those where it is absent.
This knowledge is crystallized in the
ancestral warning against settling in the
valleys and near the great waters, the
dwelling-places of disease and death. At the
same time, for security against the hostile
Mavia south of the Rovuma, it was enacted
that every settlement must be not less than a
certain distance from the southern edge of the
plateau. Such in fact is their mode of life at the
present day. It is not such a bad one, and
certainly they are both safer and more
comfortable than the Makua, the recent
intruders from the south, who have made USUAL METHOD OF
good their footing on the western edge of the CLOSING HUT-DOOR
plateau, extending over a fairly wide belt of
country. Neither Makua nor Makonde show in their dwellings
anything of the size and comeliness of the Yao houses in the plain,
especially at Masasi, Chingulungulu and Zuza’s. Jumbe Chauro, a
Makonde hamlet not far from Newala, on the road to Mahuta, is the
most important settlement of the tribe I have yet seen, and has fairly
spacious huts. But how slovenly is their construction compared with
the palatial residences of the elephant-hunters living in the plain.
The roofs are still more untidy than in the general run of huts during
the dry season, the walls show here and there the scanty beginnings
or the lamentable remains of the mud plastering, and the interior is a
veritable dog-kennel; dirt, dust and disorder everywhere. A few huts
only show any attempt at division into rooms, and this consists
merely of very roughly-made bamboo partitions. In one point alone
have I noticed any indication of progress—in the method of fastening
the door. Houses all over the south are secured in a simple but
ingenious manner. The door consists of a set of stout pieces of wood
or bamboo, tied with bark-string to two cross-pieces, and moving in
two grooves round one of the door-posts, so as to open inwards. If
the owner wishes to leave home, he takes two logs as thick as a man’s
upper arm and about a yard long. One of these is placed obliquely
against the middle of the door from the inside, so as to form an angle
of from 60° to 75° with the ground. He then places the second piece
horizontally across the first, pressing it downward with all his might.
It is kept in place by two strong posts planted in the ground a few
inches inside the door. This fastening is absolutely safe, but of course
cannot be applied to both doors at once, otherwise how could the
owner leave or enter his house? I have not yet succeeded in finding
out how the back door is fastened.

MAKONDE LOCK AND KEY AT JUMBE CHAURO

 This is the general way of closing a house. The Makonde at Jumbe
Chauro, however, have a much more complicated, solid and original
one. Here, too, the door is as already described, except that there is
only one post on the inside, standing by itself about six inches from
one side of the doorway. Opposite this post is a hole in the wall just
large enough to admit a man’s arm. The door is closed inside by a
large wooden bolt passing through a hole in this post and pressing
with its free end against the door. The other end has three holes into
which fit three pegs running in vertical grooves inside the post. The
door is opened with a wooden key about a foot long, somewhat
curved and sloped off at the butt; the other end has three pegs
corresponding to the holes, in the bolt, so that, when it is thrust
through the hole in the wall and inserted into the rectangular
opening in the post, the pegs can be lifted and the bolt drawn out.[50]

MODE OF INSERTING THE KEY

With no small pride first one householder and then a second

showed me on the spot the action of this greatest invention of the
Makonde Highlands. To both with an admiring exclamation of
“Vizuri sana!” (“Very fine!”). I expressed the wish to take back these
marvels with me to Ulaya, to show the Wazungu what clever fellows
the Makonde are. Scarcely five minutes after my return to camp at
Newala, the two men came up sweating under the weight of two
heavy logs which they laid down at my feet, handing over at the same
time the keys of the fallen fortress. Arguing, logically enough, that if
the key was wanted, the lock would be wanted with it, they had taken
their axes and chopped down the posts—as it never occurred to them
to dig them out of the ground and so bring them intact. Thus I have
two badly damaged specimens, and the owners, instead of praise,
come in for a blowing-up.
The Makua huts in the environs of Newala are especially
miserable; their more than slovenly construction reminds one of the
temporary erections of the Makua at Hatia’s, though the people here
have not been concerned in a war. It must therefore be due to
congenital idleness, or else to the absence of a powerful chief. Even
the baraza at Mlipa’s, a short hour’s walk south-east of Newala,
shares in this general neglect. While public buildings in this country
are usually looked after more or less carefully, this is in evident
danger of being blown over by the first strong easterly gale. The only
attractive object in this whole district is the grave of the late chief
Mlipa. I visited it in the morning, while the sun was still trying with
partial success to break through the rolling mists, and the circular
grove of tall euphorbias, which, with a broken pot, is all that marks
the old king’s resting-place, impressed one with a touch of pathos.
Even my very materially-minded carriers seemed to feel something
of the sort, for instead of their usual ribald songs, they chanted
solemnly, as we marched on through the dense green of the Makonde
bush:—
 “We shall arrive with the great master; we stand in a row and have
no fear about getting our food and our money from the Serkali (the
Government). We are not afraid; we are going along with the great
master, the lion; we are going down to the coast and back.”
With regard to the characteristic features of the various tribes here
on the western edge of the plateau, I can arrive at no other
conclusion than the one already come to in the plain, viz., that it is
impossible for anyone but a trained anthropologist to assign any
given individual at once to his proper tribe. In fact, I think that even
an anthropological specialist, after the most careful examination,
might find it a difficult task to decide. The whole congeries of peoples
collected in the region bounded on the west by the great Central
African rift, Tanganyika and Nyasa, and on the east by the Indian
Ocean, are closely related to each other—some of their languages are
only distinguished from one another as dialects of the same speech,
and no doubt all the tribes present the same shape of skull and
structure of skeleton. Thus, surely, there can be no very striking
differences in outward appearance.
 Even did such exist, I should have no time
to concern myself with them, for day after day,
I have to see or hear, as the case may be—in
any case to grasp and record—an
extraordinary number of ethnographic
phenomena. I am almost disposed to think it
fortunate that some departments of inquiry, at
least, are barred by external circumstances.
Chief among these is the subject of iron-
working. We are apt to think of Africa as a
country where iron ore is everywhere, so to
speak, to be picked up by the roadside, and
where it would be quite surprising if the
inhabitants had not learnt to smelt the
material ready to their hand. In fact, the
knowledge of this art ranges all over the
continent, from the Kabyles in the north to the
Kafirs in the south. Here between the Rovuma
and the Lukuledi the conditions are not so
favourable. According to the statements of the
Makonde, neither ironstone nor any other
form of iron ore is known to them. They have
not therefore advanced to the art of smelting
the metal, but have hitherto bought all their
THE ANCESTRESS OF
THE MAKONDE
iron implements from neighbouring tribes.
Even in the plain the inhabitants are not much
better off. Only one man now living is said to
understand the art of smelting iron. This old fundi lives close to
Huwe, that isolated, steep-sided block of granite which rises out of
the green solitude between Masasi and Chingulungulu, and whose
jagged and splintered top meets the traveller’s eye everywhere. While
still at Masasi I wished to see this man at work, but was told that,
frightened by the rising, he had retired across the Rovuma, though
he would soon return. All subsequent inquiries as to whether the
fundi had come back met with the genuine African answer, “Bado”
(“Not yet”).
 BRAZIER

Some consolation was afforded me by a brassfounder, whom I

came across in the bush near Akundonde’s. This man is the favourite
of women, and therefore no doubt of the gods; he welds the glittering
brass rods purchased at the coast into those massive, heavy rings
which, on the wrists and ankles of the local fair ones, continually give
me fresh food for admiration. Like every decent master-craftsman he
had all his tools with him, consisting of a pair of bellows, three
crucibles and a hammer—nothing more, apparently. He was quite
willing to show his skill, and in a twinkling had fixed his bellows on
the ground. They are simply two goat-skins, taken off whole, the four
legs being closed by knots, while the upper opening, intended to
admit the air, is kept stretched by two pieces of wood. At the lower
end of the skin a smaller opening is left into which a wooden tube is
stuck. The fundi has quickly borrowed a heap of wood-embers from
the nearest hut; he then fixes the free ends of the two tubes into an
earthen pipe, and clamps them to the ground by means of a bent
piece of wood. Now he fills one of his small clay crucibles, the dross
on which shows that they have been long in use, with the yellow
material, places it in the midst of the embers, which, at present are
only faintly glimmering, and begins his work. In quick alternation
the smith’s two hands move up and down with the open ends of the
bellows; as he raises his hand he holds the slit wide open, so as to let
the air enter the skin bag unhindered. In pressing it down he closes
the bag, and the air puffs through the bamboo tube and clay pipe into
the fire, which quickly burns up. The smith, however, does not keep
on with this work, but beckons to another man, who relieves him at
the bellows, while he takes some more tools out of a large skin pouch
carried on his back. I look on in wonder as, with a smooth round
stick about the thickness of a finger, he bores a few vertical holes into
the clean sand of the soil. This should not be difficult, yet the man
seems to be taking great pains over it. Then he fastens down to the
ground, with a couple of wooden clamps, a neat little trough made by
splitting a joint of bamboo in half, so that the ends are closed by the
two knots. At last the yellow metal has attained the right consistency,
and the fundi lifts the crucible from the fire by means of two sticks
split at the end to serve as tongs. A short swift turn to the left—a
tilting of the crucible—and the molten brass, hissing and giving forth
clouds of smoke, flows first into the bamboo mould and then into the
holes in the ground.
The technique of this backwoods craftsman may not be very far
advanced, but it cannot be denied that he knows how to obtain an
adequate result by the simplest means. The ladies of highest rank in
this country—that is to say, those who can afford it, wear two kinds
of these massive brass rings, one cylindrical, the other semicircular
in section. The latter are cast in the most ingenious way in the
bamboo mould, the former in the circular hole in the sand. It is quite
a simple matter for the fundi to fit these bars to the limbs of his fair
customers; with a few light strokes of his hammer he bends the
pliable brass round arm or ankle without further inconvenience to
the wearer.
SHAPING THE POT

SMOOTHING WITH MAIZE-COB

CUTTING THE EDGE

 FINISHING THE BOTTOM

LAST SMOOTHING BEFORE

BURNING

FIRING THE BRUSH-PILE

 LIGHTING THE FARTHER SIDE OF
THE PILE

TURNING THE RED-HOT VESSEL

NYASA WOMAN MAKING POTS AT MASASI

Pottery is an art which must always and everywhere excite the
interest of the student, just because it is so intimately connected with
the development of human culture, and because its relics are one of
the principal factors in the reconstruction of our own condition in
prehistoric times. I shall always remember with pleasure the two or
three afternoons at Masasi when Salim Matola’s mother, a slightly-
built, graceful, pleasant-looking woman, explained to me with
touching patience, by means of concrete illustrations, the ceramic art
of her people. The only implements for this primitive process were a
lump of clay in her left hand, and in the right a calabash containing
the following valuables: the fragment of a maize-cob stripped of all
its grains, a smooth, oval pebble, about the size of a pigeon’s egg, a
few chips of gourd-shell, a bamboo splinter about the length of one’s
hand, a small shell, and a bunch of some herb resembling spinach.
 Nothing more. The woman scraped with the
shell a round, shallow hole in the soft, fine
sand of the soil, and, when an active young
girl had filled the calabash with water for her,
she began to knead the clay. As if by magic it
gradually assumed the shape of a rough but
already well-shaped vessel, which only wanted
a little touching up with the instruments
before mentioned. I looked out with the
MAKUA WOMAN closest attention for any indication of the use
MAKING A POT. of the potter’s wheel, in however rudimentary
SHOWS THE a form, but no—hapana (there is none). The
BEGINNINGS OF THE embryo pot stood firmly in its little
POTTER’S WHEEL
depression, and the woman walked round it in
a stooping posture, whether she was removing
small stones or similar foreign bodies with the maize-cob, smoothing
the inner or outer surface with the splinter of bamboo, or later, after
letting it dry for a day, pricking in the ornamentation with a pointed
bit of gourd-shell, or working out the bottom, or cutting the edge
with a sharp bamboo knife, or giving the last touches to the finished
vessel. This occupation of the women is infinitely toilsome, but it is
without doubt an accurate reproduction of the process in use among
our ancestors of the Neolithic and Bronze ages.
There is no doubt that the invention of pottery, an item in human
progress whose importance cannot be over-estimated, is due to
women. Rough, coarse and unfeeling, the men of the horde range
over the countryside. When the united cunning of the hunters has
succeeded in killing the game; not one of them thinks of carrying
home the spoil. A bright fire, kindled by a vigorous wielding of the
drill, is crackling beside them; the animal has been cleaned and cut
up secundum artem, and, after a slight singeing, will soon disappear
under their sharp teeth; no one all this time giving a single thought
to wife or child.
To what shifts, on the other hand, the primitive wife, and still more
the primitive mother, was put! Not even prehistoric stomachs could
endure an unvarying diet of raw food. Something or other suggested
the beneficial effect of hot water on the majority of approved but
indigestible dishes. Perhaps a neighbour had tried holding the hard
roots or tubers over the fire in a calabash filled with water—or maybe
an ostrich-egg-shell, or a hastily improvised vessel of bark. They
became much softer and more palatable than they had previously
been; but, unfortunately, the vessel could not stand the fire and got
charred on the outside. That can be remedied, thought our
ancestress, and plastered a layer of wet clay round a similar vessel.
This is an improvement; the cooking utensil remains uninjured, but
the heat of the fire has shrunk it, so that it is loose in its shell. The
next step is to detach it, so, with a firm grip and a jerk, shell and
kernel are separated, and pottery is invented. Perhaps, however, the
discovery which led to an intelligent use of the burnt-clay shell, was
made in a slightly different way. Ostrich-eggs and calabashes are not
to be found in every part of the world, but everywhere mankind has
arrived at the art of making baskets out of pliant materials, such as
bark, bast, strips of palm-leaf, supple twigs, etc. Our inventor has no
water-tight vessel provided by nature. “Never mind, let us line the
basket with clay.” This answers the purpose, but alas! the basket gets
burnt over the blazing fire, the woman watches the process of
cooking with increasing uneasiness, fearing a leak, but no leak
appears. The food, done to a turn, is eaten with peculiar relish; and
the cooking-vessel is examined, half in curiosity, half in satisfaction
at the result. The plastic clay is now hard as stone, and at the same
time looks exceedingly well, for the neat plaiting of the burnt basket
is traced all over it in a pretty pattern. Thus, simultaneously with
pottery, its ornamentation was invented.
Primitive woman has another claim to respect. It was the man,
roving abroad, who invented the art of producing fire at will, but the
woman, unable to imitate him in this, has been a Vestal from the
earliest times. Nothing gives so much trouble as the keeping alight of
the smouldering brand, and, above all, when all the men are absent
from the camp. Heavy rain-clouds gather, already the first large
drops are falling, the first gusts of the storm rage over the plain. The
little flame, a greater anxiety to the woman than her own children,
flickers unsteadily in the blast. What is to be done? A sudden thought
occurs to her, and in an instant she has constructed a primitive hut
out of strips of bark, to protect the flame against rain and wind.
This, or something very like it, was the way in which the principle
of the house was discovered; and even the most hardened misogynist
cannot fairly refuse a woman the credit of it. The protection of the
hearth-fire from the weather is the germ from which the human
dwelling was evolved. Men had little, if any share, in this forward
step, and that only at a late stage. Even at the present day, the
plastering of the housewall with clay and the manufacture of pottery
are exclusively the women’s business. These are two very significant
survivals. Our European kitchen-garden, too, is originally a woman’s
invention, and the hoe, the primitive instrument of agriculture, is,
characteristically enough, still used in this department. But the
noblest achievement which we owe to the other sex is unquestionably
the art of cookery. Roasting alone—the oldest process—is one for
which men took the hint (a very obvious one) from nature. It must
have been suggested by the scorched carcase of some animal
overtaken by the destructive forest-fires. But boiling—the process of
improving organic substances by the help of water heated to boiling-
point—is a much later discovery. It is so recent that it has not even
yet penetrated to all parts of the world. The Polynesians understand
how to steam food, that is, to cook it, neatly wrapped in leaves, in a
hole in the earth between hot stones, the air being excluded, and
(sometimes) a few drops of water sprinkled on the stones; but they
do not understand boiling.
To come back from this digression, we find that the slender Nyasa
woman has, after once more carefully examining the finished pot,
put it aside in the shade to dry. On the following day she sends me
word by her son, Salim Matola, who is always on hand, that she is
going to do the burning, and, on coming out of my house, I find her
already hard at work. She has spread on the ground a layer of very
dry sticks, about as thick as one’s thumb, has laid the pot (now of a
yellowish-grey colour) on them, and is piling brushwood round it.
My faithful Pesa mbili, the mnyampara, who has been standing by,
most obligingly, with a lighted stick, now hands it to her. Both of
them, blowing steadily, light the pile on the lee side, and, when the
flame begins to catch, on the weather side also. Soon the whole is in a
blaze, but the dry fuel is quickly consumed and the fire dies down, so
that we see the red-hot vessel rising from the ashes. The woman
turns it continually with a long stick, sometimes one way and
sometimes another, so that it may be evenly heated all over. In
twenty minutes she rolls it out of the ash-heap, takes up the bundle
of spinach, which has been lying for two days in a jar of water, and
sprinkles the red-hot clay with it. The places where the drops fall are
marked by black spots on the uniform reddish-brown surface. With a
sigh of relief, and with visible satisfaction, the woman rises to an
erect position; she is standing just in a line between me and the fire,
from which a cloud of smoke is just rising: I press the ball of my
camera, the shutter clicks—the apotheosis is achieved! Like a
priestess, representative of her inventive sex, the graceful woman
stands: at her feet the hearth-fire she has given us beside her the
invention she has devised for us, in the background the home she has
built for us.
At Newala, also, I have had the manufacture of pottery carried on
in my presence. Technically the process is better than that already
described, for here we find the beginnings of the potter’s wheel,
which does not seem to exist in the plains; at least I have seen
nothing of the sort. The artist, a frightfully stupid Makua woman, did
not make a depression in the ground to receive the pot she was about
to shape, but used instead a large potsherd. Otherwise, she went to
work in much the same way as Salim’s mother, except that she saved
herself the trouble of walking round and round her work by squatting
at her ease and letting the pot and potsherd rotate round her; this is
surely the first step towards a machine. But it does not follow that
the pot was improved by the process. It is true that it was beautifully
rounded and presented a very creditable appearance when finished,
but the numerous large and small vessels which I have seen, and, in
part, collected, in the “less advanced” districts, are no less so. We
moderns imagine that instruments of precision are necessary to
produce excellent results. Go to the prehistoric collections of our
museums and look at the pots, urns and bowls of our ancestors in the
dim ages of the past, and you will at once perceive your error.
MAKING LONGITUDINAL CUT IN
BARK

DRAWING THE BARK OFF THE LOG

REMOVING THE OUTER BARK

 BEATING THE BARK

WORKING THE BARK-CLOTH AFTER BEATING, TO MAKE IT

SOFT

MANUFACTURE OF BARK-CLOTH AT NEWALA

To-day, nearly the whole population of German East Africa is
clothed in imported calico. This was not always the case; even now in
some parts of the north dressed skins are still the prevailing wear,
and in the north-western districts—east and north of Lake
Tanganyika—lies a zone where bark-cloth has not yet been
superseded. Probably not many generations have passed since such
bark fabrics and kilts of skins were the only clothing even in the
south. Even to-day, large quantities of this bright-red or drab
material are still to be found; but if we wish to see it, we must look in
the granaries and on the drying stages inside the native huts, where
it serves less ambitious uses as wrappings for those seeds and fruits
which require to be packed with special care. The salt produced at
Masasi, too, is packed for transport to a distance in large sheets of
bark-cloth. Wherever I found it in any degree possible, I studied the
process of making this cloth. The native requisitioned for the
purpose arrived, carrying a log between two and three yards long and
as thick as his thigh, and nothing else except a curiously-shaped
mallet and the usual long, sharp and pointed knife which all men and
boys wear in a belt at their backs without a sheath—horribile dictu!
[51]
Silently he squats down before me, and with two rapid cuts has
drawn a couple of circles round the log some two yards apart, and
slits the bark lengthwise between them with the point of his knife.
With evident care, he then scrapes off the outer rind all round the
log, so that in a quarter of an hour the inner red layer of the bark
shows up brightly-coloured between the two untouched ends. With
some trouble and much caution, he now loosens the bark at one end,
and opens the cylinder. He then stands up, takes hold of the free
edge with both hands, and turning it inside out, slowly but steadily
pulls it off in one piece. Now comes the troublesome work of
scraping all superfluous particles of outer bark from the outside of
the long, narrow piece of material, while the inner side is carefully
scrutinised for defective spots. At last it is ready for beating. Having
signalled to a friend, who immediately places a bowl of water beside
him, the artificer damps his sheet of bark all over, seizes his mallet,
lays one end of the stuff on the smoothest spot of the log, and
hammers away slowly but continuously. “Very simple!” I think to
myself. “Why, I could do that, too!”—but I am forced to change my
opinions a little later on; for the beating is quite an art, if the fabric is
not to be beaten to pieces. To prevent the breaking of the fibres, the
stuff is several times folded across, so as to interpose several
thicknesses between the mallet and the block. At last the required
state is reached, and the fundi seizes the sheet, still folded, by both
ends, and wrings it out, or calls an assistant to take one end while he
holds the other. The cloth produced in this way is not nearly so fine
and uniform in texture as the famous Uganda bark-cloth, but it is
quite soft, and, above all, cheap.
Now, too, I examine the mallet. My craftsman has been using the
simpler but better form of this implement, a conical block of some
hard wood, its base—the striking surface—being scored across and
across with more or less deeply-cut grooves, and the handle stuck
into a hole in the middle. The other and earlier form of mallet is
shaped in the same way, but the head is fastened by an ingenious
network of bark strips into the split bamboo serving as a handle. The
observation so often made, that ancient customs persist longest in
connection with religious ceremonies and in the life of children, here
finds confirmation. As we shall soon see, bark-cloth is still worn
during the unyago,[52] having been prepared with special solemn
ceremonies; and many a mother, if she has no other garment handy,
will still put her little one into a kilt of bark-cloth, which, after all,
looks better, besides being more in keeping with its African
surroundings, than the ridiculous bit of print from Ulaya.
MAKUA WOMEN