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J. William Petty, PhD, Baylor University, is Professor of Finance and
W. W. Caruth Chair of Entrepreneurship. Dr. Petty teaches entrepreneurial finance
at both the undergraduate and graduate levels. He is a University Master Teacher.
In 2008, the Acton Foundation for Entrepreneurship Excellence selected him as the
National Entrepreneurship Teacher of the Year. His research interests include the
financing of entrepreneurial firms and shareholder value-based management. He
has served as the co-editor for the Journal of Financial Research and the editor of the
Journal of Entrepreneurial Finance. He has published articles in various academic and
professional journals, including Journal of Financial and Quantitative Analysis, Financial
Management, Journal of Portfolio Management, Journal of Applied Corporate Finance, and
Accounting Review. Dr. Petty is co-author of a leading textbook in small business and
entrepreneurship, Small Business Management: Launching and Growing Entrepreneurial
Ventures. He also co-authored Value-Based Management: Corporate America’s Response
to the Shareholder Revolution (2010). He serves on the Board of Directors of a publicly
traded oil and gas firm. Finally, he serves on the Board of the Baylor Angel Network,
a network of private investors who provide capital to start-ups and early-stage
companies.
vii
Brief Contents
Preface xvii
PART 1 The Scope and Environment

of Financial Management 2
1 An Introduction to the Foundations of Financial Management 2
2 The Financial Markets and Interest Rates 22
3 Understanding Financial Statements and Cash Flows 54
4 Evaluating a Firm’s Financial Performance 106
PART 2 The Valuation of Financial Assets 152

5 The Time Value of Money 152
6 The Meaning and Measurement of Risk and Return 196
7 The Valuation and Characteristics of Bonds 236
8 The Valuation and Characteristics of Stock 268
9 The Cost of Capital 294
PART 3 Investment in Long-Term Assets 326

10 Capital-Budgeting Techniques and Practice 326
11 Cash Flows and Other Topics in Capital Budgeting 368
PART 4 Capital Structure and Dividend Policy 406

12 Determining the Financing Mix 406
13 Dividend Policy and Internal Financing 444
PART 5 Working-Capital Management and International

Business Finance 466
14 Short-Term Financial Planning 466
15 Working-Capital Management 486
16 International Business Finance 514
Web 17 Cash, Receivables, and Inventory Management
Available online at www.myfinancelab.com
Web Appendix A Using a Calculator
Glossary 536
Indexes 545
viii
Contents
Preface xvii
PART 1 The Scope and Environment

of Financial Management 2
1 An Introduction to the Foundations of Financial

Management 2
The Goal of the Firm 3
Five Principles That Form the Foundations of Finance 4
Principle 1: Cash Flow Is What Matters 4
Principle 2: Money Has a Time Value 5
Principle 3: Risk Requires a Reward 5
Principle 4: Market Prices Are Generally Right 6
Principle 5: Conflicts of Interest Cause Agency Problems 8
The Global Financial Crisis 9
Avoiding Financial Crisis—Back to the Principles 10
The Essential Elements of Ethics and Trust 11
The Role of Finance in Business 12
Why Study Finance? 12
The Role of the Financial Manager 13
The Legal Forms of Business Organization 14
Sole Proprietorships 14
Partnerships 14
Corporations 15
Organizational Form and Taxes: The Double Taxation on Dividends 15
S-Corporations and Limited Liability Companies (LLCs) 16
Which Organizational Form Should Be Chosen? 16
Finance and the Multinational Firm: The New Role 17
Chapter Summaries 18 • Review Questions 20 • Mini Case 21
2 The Financial Markets and Interest Rates 22

Financing of Business: The Movement of Funds Through
the Economy 24
Public Offerings Versus Private Placements 25
Primary Markets Versus Secondary Markets 26
The Money Market Versus the Capital Market 27
Spot Markets Versus Futures Markets 27
Stock Exchanges: Organized Security Exchanges Versus Over-the-Counter
Markets, a Blurring Difference 27
Selling Securities to the Public 29
Functions 29
Distribution Methods 30
Private Debt Placements 31
Flotation Costs 33
Regulation Aimed at Making the Goal of the Firm Work: The Sarbanes-Oxley
Act 33
Rates of Return in the Financial Markets 34
Rates of Return over Long Periods 34
Interest Rate Levels in Recent Periods 35
ix
x Contents
Interest Rate Determinants in a Nutshell 38

Estimating Specific Interest Rates Using Risk Premiums 38
Real Risk-Free Interest Rate and the Risk-Free Interest Rate 39
Real and Nominal Rates of Interest 39
Inflation and Real Rates of Return: The Financial Analyst’s Approach 41
The Term Structure of Interest Rates 43
Shifts in the Term Structures of Interest Rates 43
What Explains the Shape of the Term Structure? 45
Chapter Summaries 47 • Review Questions 50 • Study Problems 50 • Mini Case 53
3 Understanding Financial Statements and Cash

Flows 54
The Income Statement 56
Coca-Cola’s Income Statement 58
Restating Coca-Cola’s Income Statement 59
The Balance Sheet 61
Types of Assets 61
Types of Financing 63
Coca-Cola’s Balance Sheet 65
Working Capital 66
Measuring Cash Flows 69
Profits Versus Cash Flows 69
The Beginning Point: Knowing When a Change in the Balance Sheet Is a Source
or Use of Cash 71
Statement of Cash Flows 71
Concluding Suggestions for Computing Cash Flows 78
What Have We Learned about Coca-Cola? 79
GAAP and IFRS 79
Income Taxes and Finance 80
Computing Taxable Income 80
Computing the Taxes Owed 81
The Limitations of Financial Statements and Accounting
Malpractice 83
Chapter Summaries 85 • Review Questions 88 • Study Problems 89 • Mini Case 97
Appendix 3A: Free Cash Flows 100

Computing Free Cash Flows 100
Computing Financing Cash Flows 105
Study Problems 104
4 Evaluating a Firm’s Financial Performance 106

The Purpose of Financial Analysis 106
Measuring Key Financial Relationships 110
Question 1: How Liquid Is the Firm—Can It Pay Its Bills? 111
Question 2: Are the Firm’s Managers Generating Adequate Operating Profits
on the Company’s Assets? 116
Managing Operations 118
Managing Assets 119
Question 3: How Is the Firm Financing Its Assets? 123
Question 4: Are the Firm’s Managers Providing a Good Return on the Capital
Provided by the Company’s Shareholders? 126
Question 5: Are the Firm’s Managers Creating Shareholder Value? 131
Contents xi
The Limitations of Financial Ratio Analysis 138
Chapter Summaries 139 • Review Questions 142 • Study Problems 142

• Mini Case 150
PART 2 The Valuation of Financial Assets 152
5 The Time Value of Money 152

Compound Interest, Future Value, and Present Value 154
Using Timelines to Visualize Cash Flows 154
Techniques for Moving Money Through Time 157
Two Additional Types of Time Value of Money Problems 162
Applying Compounding to Things Other Than Money 163
Present Value 164
Annuities 168
Compound Annuities 168
The Present Value of an Annuity 170
Annuities Due 172
Amortized Loans 173
Making Interest Rates Comparable 175
Calculating the Interest Rate and Converting It to an EAR 177
Finding Present and Future Values With Nonannual Periods 178
Amortized Loans With Monthly Compounding 181
The Present Value of an Uneven Stream and Perpetuities 182
Perpetuities 183

• Mini Case 195
6 The Meaning and Measurement of Risk

and Return 196
Expected Return Defined and Measured 198
Risk Defined and Measured 201
Rates of Return: The Investor’s Experience 208
Risk and Diversification 209
Diversifying Away the Risk 210
Measuring Market Risk 211
Measuring a Portfolio’s Beta 218
Risk and Diversification Demonstrated 219
The Investor’s Required Rate of Return 222
The Required Rate of Return Concept 222
Measuring the Required Rate of Return 222

• Mini Case 234
7 The Valuation and Characteristics

of Bonds 236
Types of Bonds 237
Debentures 237
Subordinated Debentures 238
Mortgage Bonds 238
Eurobonds 238
Convertible Bonds 238
xii Contents
Terminology and Characteristics of Bonds 239

Claims on Assets and Income 239
Par Value 239
Coupon Interest Rate 240
Maturity 240
Call Provision 240
Indenture 240
Bond Ratings 241
Defining Value 242
What Determines Value? 244
Valuation: The Basic Process 245
Valuing Bonds 246
Bond Yields 252
Yield to Maturity 252
Current Yield 254
Bond Valuation: Three Important Relationships 255

• Mini Case 267
8 The Valuation and Characteristics

of Stock 268
Preferred Stock 269
The Characteristics of Preferred Stock 270
Valuing Preferred Stock 271
Common Stock 275
The Characteristics of Common Stock 275
Valuing Common Stock 277
The Expected Rate of Return of Stockholders 282
The Expected Rate of Return of Preferred Stockholders 283
The Expected Rate of Return of Common Stockholders 284

• Mini Case 293
9 The Cost of Capital 294

The Cost of Capital: Key Definitions and Concepts 295
Opportunity Costs, Required Rates of Return, and the Cost of
Capital 295
The Firm’s Financial Policy and the Cost of Capital 296
Determining the Costs of the Individual Sources
of Capital 297
The Cost of Debt 297
The Cost of Preferred Stock 299
The Cost of Common Equity 301
The Dividend Growth Model 302
Issues in Implementing the Dividend Growth Model 303
The Capital Asset Pricing Model 304
Issues in Implementing the CAPM 305
The Weighted Average Cost of Capital 307
Capital Structure Weights 308
Calculating the Weighted Average Cost of Capital 308
Contents xiii
Calculating Divisional Costs of Capital 311

Estimating Divisional Costs of Capital 311
Using Pure Play Firms to Estimate Divisional WACCs 311
Using a Firm’s Cost of Capital to Evaluate New Capital Investments 313

• Mini Cases 324
PART 3 Investment in Long-Term Assets 326
10 Capital-Budgeting Techniques and Practice 326

Finding Profitable Projects 327
Capital-Budgeting Decision Criteria 328
The Payback Period 328
The Net Present Value 332
Using Spreadsheets to Calculate the Net Present Value 335
The Profitability Index (Benefit–Cost Ratio) 335
The Internal Rate of Return 338
Computing the IRR for Uneven Cash Flows with a Financial Calculator 340
Viewing the NPV–IRR Relationship: The Net Present Value Profile 341
Complications with the IRR: Multiple Rates of Return 343
The Modified Internal Rate of Return (MIRR) 344
Using Spreadsheets to Calculate the MIRR 347
A Last Word on the MIRR 347
Capital Rationing 348
The Rationale for Capital Rationing 349
Capital Rationing and Project Selection 349
Ranking Mutually Exclusive Projects 350
The Size-Disparity Problem 350
The Time-Disparity Problem 351
The Unequal-Lives Problem 352

• Mini Case 366
11 Cash Flows and Other Topics in Capital

Budgeting 368
Guidelines for Capital Budgeting 369
Use Free Cash Flows Rather Than Accounting Profits 369
Think Incrementally 369
Beware of Cash Flows Diverted from Existing Products 370
Look for Incidental or Synergistic Effects 370
Work in Working-Capital Requirements 370
Consider Incremental Expenses 371
Remember That Sunk Costs Are Not Incremental Cash Flows 371
Account for Opportunity Costs 371
Decide If Overhead Costs Are Truly Incremental Cash Flows 371
Ignore Interest Payments and Financing Flows 372
Calculating a Project’s Free Cash Flows 372
What Goes into the Initial Outlay 372
What Goes into the Annual Free Cash Flows over the Project’s Life 373
What Goes into the Terminal Cash Flow 375
Calculating the Free Cash Flows 375
A Comprehensive Example: Calculating Free Cash Flows 379
Options in Capital Budgeting 382
The Option to Delay a Project 383
The Option to Expand a Project 383
The Option to Abandon a Project 384
Options in Capital Budgeting: The Bottom Line 384
xiv Contents
Risk and the Investment Decision 385

What Measure of Risk Is Relevant in Capital Budgeting? 386
Measuring Risk for Capital-Budgeting Purposes with a Dose of Reality—Is
Systematic Risk All There Is? 387
Incorporating Risk into Capital Budgeting 387
Risk-Adjusted Discount Rates 387
Measuring a Project’s Systematic Risk 390
Using Accounting Data to Estimate a Project’s Beta 391
The Pure Play Method for Estimating Beta 391
Examining a Project’s Risk Through Simulation 391
Conducting a Sensitivity Analysis Through Simulation 393

• Mini Case 402
Appendix 11A: The Modified Accelerated Cost

Recovery System 404
What Does All This Mean? 405
Study Problems 405
PART 4 Capital Structure and Dividend Policy 406
12 Determining the Financing Mix 406

Understanding the Difference Between Business and Financial
Risk 408
Business Risk 409
Operating Risk 409
Break-Even Analysis 409
Essential Elements of the Break-Even Model 410
Finding the Break-Even Point 412
The Break-Even Point in Sales Dollars 413
Sources of Operating Leverage 414
Financial Leverage 416
Combining Operating and Financial Leverage 418
Capital Structure Theory 420
A Quick Look at Capital Structure Theory 422
The Importance of Capital Structure 422
Independence Position 422
The Moderate Position 424
Firm Value and Agency Costs 426
Agency Costs, Free Cash Flow, and Capital Structure 428
Managerial Implications 428
The Basic Tools of Capital Structure Management 429
EBIT-EPS Analysis 429
Comparative Leverage Ratios 432
Industry Norms 433
Net Debt and Balance-Sheet Leverage Ratios 433
A Glance at Actual Capital Structure Management 433

• Mini Cases 442
13 Dividend Policy and Internal Financing 444

Key Terms 445
Does Dividend Policy Matter to Stockholders? 446
Three Basic Views 446
Making Sense of Dividend Policy Theory 449
What Are We to Conclude? 451
Contents xv
The Dividend Decision in Practice 452

Legal Restrictions 452
Liquidity Constraints 452
Earnings Predictability 453
Maintaining Ownership Control 453
Alternative Dividend Policies 453
Dividend Payment Procedures 453
Stock Dividends and Stock Splits 454
Stock Repurchases 455
A Share Repurchase as a Dividend Decision 456
The Investor’s Choice 457
A Financing or an Investment Decision? 458
Practical Considerations—The Stock Repurchase Procedure 458

• Mini Case 465
PART 5 Working-Capital Management and International

Business Finance 466
14 Short-Term Financial Planning 466

Financial Forecasting 467
The Sales Forecast 467
Forecasting Financial Variables 467
The Percent of Sales Method of Financial Forecasting 468
Analyzing the Effects of Profitability and Dividend Policy
on DFN 469
Analyzing the Effects of Sales Growth on a Firm’s DFN 470
Limitations of the Percent of Sales Forecasting Method 473
Constructing and Using a Cash Budget 474
Budget Functions 474
The Cash Budget 475

• Mini Case 484
15 Working-Capital Management 486

Managing Current Assets and Liabilities 487
The Risk–Return Trade-Off 488
The Advantages of Current versus Long-term Liabilities: Return 488
The Disadvantages of Current versus Long-term Liabilities: Risk 488
Determining the Appropriate Level of Working
Capital 489
The Hedging Principle 489
Permanent and Temporary Assets 490
Temporary, Permanent, and Spontaneous Sources of Financing 490
The Hedging Principle: A Graphic Illustration 491
The Cash Conversion Cycle 492
Estimating the Cost of Short-Term Credit Using the Approximate
Cost-of-Credit Formula 494
Sources of Short-Term Credit 496
Unsecured Sources: Accrued Wages and Taxes 497
Unsecured Sources: Trade Credit 498
Unsecured Sources: Bank Credit 499
Unsecured Sources: Commercial Paper 501
xvi Contents
Secured Sources: Accounts-Receivable Loans 503

Secured Sources: Inventory Loans 505
16 International Business Finance 514

The Globalization of Product and Financial Markets 515
Foreign Exchange Markets and Currency Exchange Rates 516
Foreign Exchange Rates 517
What a Change in the Exchange Rate Means for Business 517
Exchange Rates and Arbitrage 520
Asked and Bid Rates 520
Cross Rates 520
Types of Foreign Exchange Transactions 522
Exchange Rate Risk 524
Interest Rate Parity 526
Purchasing-Power Parity and the Law of One Price 527
The International Fisher Effect 528
Capital Budgeting for Direct Foreign Investment 528
Foreign Investment Risks 529

• Mini Case 534
Web 17 Cash, Receivables, and Inventory Management

Web Appendix A Using a Calculator

Glossary 536
Indexes 545
Preface
The study of finance focuses on making decisions that enhance the value of the firm.
This is done by providing customers with the best products and services in a cost-
effective way. In a sense we, the authors of Foundations of Finance, share the same
purpose. We have tried to create a product that provides value to our customers—
both students and instructors who use the text. It was this priority that led us to write
Foundations of Finance: The Logic and Practice of Financial Management, which was the
first “shortened book” of financial management when it was first published. This
text launched a trend that has since been followed by all the major competing texts
in this market. The text broke new ground not only by reducing the breadth of mate-
rials covered but also by employing a more intuitive approach to presenting new
material. From that first edition, the text has met with success beyond our expecta-
tions for eight editions. For that success, we are eternally grateful to the multitude of
finance instructors who have chosen to use the text in their classrooms.
New to the Ninth Edition

Technology is ever present in our lives today, and we are beginning to see its effec-
tive use in education. One form of learning technology that we believe has great
merit today is the lecture video. For all the numbered in-text examples in the Ninth
Edition, we have recorded brief (10- to 15-minute) lecture videos that students can
replay as many times as they need to help them understand more fully each of the
in-text examples. We are confident that many students will enjoy having the authors
“tutoring” them when it comes to the primary examples in the text. The videos can
be found in the eText within MyFinanceLab.
In addition to the innovations of this edition, we have made some chapter-by-
chapter updates in response to the continued development of financial thought,
reviewer comments, and the recent economic crisis. Some of these changes include:
Chapter 1
An Introduction to the Foundations of Financial Management
◆ Revised and updated chapter introduction
◆ Revised and updated discussion of the five principles
Chapter 2
The Financial Markets and Interest Rates
◆ Revised coverage of the term structure of interest rates to address the very low
rates that characterize today’s markets
◆ Simplified, more intuitive discussion on interest rate determinants
◆ Added coverage of the term structure of interest rates into the end-of-chapter
problems
Chapter 3
Understanding Financial Statements and Cash Flows
◆ Uses The Coca-Cola Company, a firm all students are familiar with, to help them
understand financial statements
◆ Expanded coverage of balance sheets, focusing on what can be learned from them
xvii
xviii Preface
◆ More intuitive presentation of cash flows

◆ New explanation of fixed and variable costs as part of presenting an income
statement
◆ Four lecture videos accompany the in-chapter examples.
Chapter 4
Evaluating a Firm’s Financial Performance
◆ Continues the use of The Coca-Cola Company’s financial data to illustrate how
we evaluate a firm’s financial performance, compared to industry norms or a
peer group. In this case, we compare Coca-Cola’s financial performance to that of
PepsiCo, a major competitor.
◆ Provides a new Finance at Work box, based on an example from the soft-drink
industry
◆ Revised presentation of evaluating a company’s liquidity to align more closely
with how business managers talk about liquidity
Chapter 5
The Time Value of Money
◆ Revised to appeal to all students regardless of their level of mathematical skill
◆ New section added on “Making Interest Rates Comparable,” with new end-of-
chapter questions dealing with calculation of the effective annual rate
◆ Additional problems emphasizing complex streams of cash flows
◆ Thirteen lecture videos accompany the in-chapter examples.
Chapter 6
The Meaning and Measurement of Risk and Return
◆ Updated information on the rates of return that investors have earned over the
long term with different types of security investments
◆ Numerous new examples involving companies the students are familiar with are
presented throughout the chapter to illustrate the concepts and applications in
the chapter.
◆ Two lecture videos accompany the in-chapter examples.
Chapter 7
The Valuation and Characteristics of Bonds
◆ A number of new examples involving real-life firms
Chapter 8
The Valuation and Characteristics of Stock
◆ More current explanation of options for getting stock quotes from the Wall Street
Journal
Chapter 9
The Cost of Capital
◆ Five lecture videos correspond to the five major in-chapter examples
◆ Eight end-of-chapter problems revised or replaced by new problem exercises
Preface xix
Chapter 10
Capital-Budgeting Techniques and Practice
◆ Extensively revised chapter introduction, which looks at Disney’s decision to
build the Shanghai Disney Resort
◆ Addition of a new section along with additional discussion of the modified inter-
nal rate of return that not only summarizes the tool, but also provides important
caveats concerning its use
◆ Eight lecture videos accompany the in-chapter examples.
Chapter 11
Cash Flows and Other Topics in Capital Budgeting
◆ Revised introduction examining the difficulties Toyota faced in estimating future
cash flows when it introduced the Prius
◆ New Finance at Work box dealing with Disney World
◆ Problem set revised to include additional coverage of real options
◆ Three lecture videos accompany the in-chapter examples.
Chapter 12
Determining the Financing Mix
◆ Problem set revised to include two new and one revised exercise
Chapter 13
Dividend Policy and Internal Financing
◆ Updated discussion of the tax code for personal tax treatment of dividends and
capital gains
◆ A lecture video accompanies the in-chapter example.
Chapter 14
Short-Term Financial Planning
◆ Two new problems added
Chapter 15
Working-Capital Management
◆ Four new problem exercises added
◆ Five lecture videos accompany the in-chapter examples.
Chapter 16
International Business Finance
◆ Revised extensively to reflect changes in exchange rates and global financial markets
◆ A new section titled “What a Change in the Exchange Rate Means for Business”
deals with the implications of exchange rate changes
◆ Three lecture videos accompany the in-chapter examples.
Web Chapter 17
Cash, Receivables, and Inventory Management
◆ Simplified presentation of chapter materials
value of the firm’s stock to evaluate financial decisions. Many things affect stock
prices; to attempt to identify a reaction to a particular financial decision would sim-
ply be impossible, but fortunately that is unnecessary. To employ this goal, we need
not consider every stock price change to be a market interpretation of the worth of
xx Preface our decisions. Other factors, such as changes in the economy, also affect stock prices.
What we do focus on is the effect that our decision should have on the stock price if
everything else were held constant. The market price of the firm’s stock reflects the
value of the firm as seen by its owners and takes into account the complexities and
complications of the real-world risk. As we follow this goal throughout our discus-
sions, we must keep in mind one more question: Who exactly are the shareholders?
Pedagogy That Works

The answer: Shareholders are the legal owners of the firm.
Concept Check
In our opinion, the success of this textbook derives from our focus on maintaining
1. What is the goal of the firm?
2. How would you apply this goal in practice?
pedagogy that works. We endeavor to provide students with a conceptual understand-
ing of the financial decision-making
process that includes a survey of the
LO2 Understand the basic Five Principles That Form the Foundations
principles of finance,
tools and techniques of finance. For
their importance, and the
of Finance
importance of ethics and trust.
the student, it is all too easy to lose
To the first-time student of finance, the subject matter may seem like a collection of
unrelated decision rules. This impression could not be further from the truth. In fact, sight of the logic that drives finance
our decision rules, and the logic that underlies them, spring from five simple princi-
ples that do not require knowledge of finance to understand. These five principles and to focus instead on memoriz-
guide the financial manager in the creation of value for the firm’s owners (the stock- ing formulas and procedures. As
holders).
As you will see, although it is not necessary to understand finance to understand a result, students have a difficult
these principles, it is necessary to understand these principles in order to understand
finance. These principles may at first appear simple or even trivial, but they provide time understanding the interrela-
the driving force behind all that follows, weaving together the concepts and tech- tionships among the topics covered.
niques presented in this text, and thereby allowing us to focus on the logic underly-
ing the practice of financial management. Now let’s introduce the five principles. Moreover, later in life, when the
problems encountered do not match
PRINCIPLE
Principle 1: Cash Flow Is What Matters
1 the textbook presentation, students
You probably recall from your accounting classes that a company’s profits can differ
dramatically from its cash flows, which we will review in Chapter 3. But for now may find themselves unprepared
understand that cash flows, not profits, represent money that can be spent.
Consequently, it is cash flow, not profits, that determines the value of a business. For to abstract from what they have
this reasonlearned.
when we analyzeWe thehave worked
consequences to be
of a managerial “good
decision, at
we focusthe
on basics.” To achieve this goal, we have
the resulting cash flows, not profits.
In the refined
movie industry,thethere
book over
is a big thebetween
difference last eight editions
accounting profits andto include the following features.
cash flow. Many a movie is crowned a success and brings in plenty of cash flow for
the studio but doesn’t produce a profit. Even some of the most successful box office
Building on Foundational Finance Principles

hits—Forrest Gump, Coming to America, Batman, My Big Fat Greek Wedding, and the TV
series Babylon 5—realized no accounting profits at all after accounting for various
movie studio costs. That’s because “Hollywood Accounting” allows for overhead
costs not associated with the movie to be added on to the true cost of the movie. In
Chapter 1 presents five foundational principles of finance which are the threads that
fact, the movie Harry Potter and the Order of the Phoenix, which grossed almost $1 bil-
bind all the topics of the book. Then throughout the text, we provide reminders of
lion worldwide, actually lost $167 million according to the accountants. Was Harry
Potter and the Order of the Phoenix a successful movie? It certainly was—in fact, it was
the foundational principles in “Remember Your Principles” boxes.
the 27th highest grossing film of all time. Without question, it produced cash, but it
didn’t make any profits.
The five principles of finance allow us to provide an introduction to financial
decision making rooted in current financial theory and in the current state of world
economic conditions. What results is an introductory treatment of a discipline rather
M01_KEOW3285_09_SE_C01.indd 4
than the treatment of a series of isolated financial problems that managers encounter.
28/11/15 2:53 PM
Use of an Integrated Learning System

The text is organized around the learning objectives that appear at the beginning of
each chapter to provide the instructor and student with an easy-to-use integrated
learning system. Numbered icons identifying each objective appear next to the
related material throughout the text and in the summary, allowing easy location of
material related to each objective.
A Focus on Valuation
Although many professors and instructors make valuation the central theme of their
course, students often lose sight of this focus when reading their text. We reinforce
this focus in the content and organization of our text in some very concrete ways:
◆ We build our discussion around the five finance principles that provide the foun-
dation for the valuation of any investment.
◆ We introduce new topics in the context of “what is the value proposition?” and
“how is the value of the enterprise affected?”
Real-World Opening Vignettes

Each chapter begins with a story about a current, real-world company faced with a
financial decision related to the chapter material that follows. These vignettes have
Preface xxi
been carefully prepared to stimulate student interest in the topic to come and can be
used as a lecture tool to provoke class discussion.
• The Financial Markets and Interest Rates 41
A Step-by-Step Approach to Problem Solving
CHAPTER 2
and Analysis someone for 1 year at a nominal rate of interest of 11.3 percent. This means you will
get back $111.30 in 1 year. But if during the year, the prices of goods and services rise
by 5 percent, it will take $105 at year-end to purchase the same goods and services
As anyone who has taught the core undergraduate
that $100 purchasedfinance course
at the beginning knows,
of the year. What wasstudents
your increase in purchas-
ing power over the year? The quick and dirty answer is found by subtracting the
demonstrate a wide range of math comprehension and
inflation rate from the skill.
nominal rate,Students
11.3% 2 5% 5 who 6.3%, butdo
this not
is not exactly cor-
have the math skills needed to master therect.
subject sometimes end up memorizing for-
We can also express the relationship among the nominal interest rate, the rate of
inflation (that is, the inflation premium), and the real rate of interest as follows:
mulas rather than focusing on the analysis of1 1business
nominal interest decisions using
rate 5 (1 1 real math 1asratea oftool.
rate of interest)(1 inflation) (2-3)
We address this problem in terms of both text content
Solving andrate
for the nominal pedagogy.
of interest,
Nominal interest rate
◆ First, we present math only as a tool to help
5 realus
rateanalyze
of interest 1 problems,
rate of inflation 1and only
(real rate when
of interest) (rate of inflation)
necessary. We do not present math for its own sake.
Consequently, the nominal rate of interest is equal to the sum of the real rate of
interest, the inflation rate, and the product of the real rate and the inflation rate. This
◆ Second, finance is an analytical subject andamong
relationship requires that
nominal rates, realstudents beof able
rates, and the rate inflationto
has come to be
called the Fisher effect. What does the product of the real rate of interest and the infla-
solve problems. To help with this process, numbered chapter examples appear
tion rate represent? It represents the fact that the money you earn on your investment
throughout the book. All of these examples follow
is worth less because a very
of inflation. detailed
All this demonstratesand struc-
that the observed nominal
rate of interest includes both the real rate and an inflation premium.
tured three-step approach to problem solving
Substituting that helps
into equation (2-3)students
using a nominaldevelop theirand an infla-
rate of 11.3 percent
tion rate of 5 percent, we can calculate the real rate of interest as follows:
problem-solving skills:
Nominal or quoted 5 real rate of interest 1 inflation 1 product of the real rate of
Step 1: Formulate a Solution Strategy. For example,
rate of interest
0.113
what is the appropriate
5 real rate of interest 1
rate
0.05
for-
interest and the inflation rate
1 0.05 3 real rate of interest
mula to apply? How can a calculator or 0.063spreadsheet5 1.05 3 real be
rate ofused
interest to “crunch the
numbers”? 0.063/1.05 5 real rate of interest
Step 2: Crunch the Numbers. Here we provide

Solving for thearealcompletely
rate of interest: worked out step-by-
step solution. We present first a description of the solution in prose and then a
Real rate of interest = 0.06 = 6%
Thus, at the new higher prices, your purchasing power will have increased by only 6
corresponding mathematical implementation.percent, although you have $11.30 more than you had at the start of the year. To see why,
Step 3: Analyze Your Results. We end each solution
let’s assume withof an
that at the outset analysis
the year, one unit ofof whatbasket
the market theof goods and
services cost $1, so you could purchase 100 units with your $100. At the end of the year,
solution means. This stresses the pointyou thathaveproblem
$11.30 more, butsolving
each unit nowis about
costs $1.05analysis
(remember the and
5 percent rate of
inflation). How many units can you buy at the end of the year? The answer is
decision making. Moreover, in this step we emphasize that decisions are often
$111.30 4 $1.05 5 106, which represents a 6 percent increase in real purchasing power. 2
based on incomplete information, which requires the exercise of managerial

Inflation and Real Rates of Return: The Financial
judgment, a fact of life that is often learned
Analyst’s onApproach
the job.
Although the algebraic methodology presented in the previous section is strictly cor-
rect, few practicing analysts or executives use it. Rather, they employ some version of
“Can You Do It?” and CAN YOU DO IT?

“Did You Get It?” Solving for the Real Rate of Interest
Your banker just called and offered you the chance to invest your savings for 1 year at a quoted rate of 10 percent. You also saw on
The text provides examples for the 42 solution PART 1 • The Scope and Environment of Financial Management
the news that the inflation rate is 6 percent. What is the real rate of interest you would be earning if you made the investment? (The
can be found on page 42.)
students to work at the conclusion

12 section
of each major PART 1 • The Scope and Environment
DID YOU
of a chapter, In Chapter GET IT?Management
of Financial
2
5, we will study more about the time value of money.
which we call “Can You Do It?,” fol- Solving for the Real Rate of Interest
lowed by “Did You Get It?” later in right thing.” NominalInoraquoted
sense,5we can
rate of interest
realthink
rate of of laws
interest
asrate
a set1ofinterest
1 inflation rules that
product of reflect
the real rate ofthe values of
and the inflation rate
the chapter. This tool provides an a society as a whole.
0.10 5 real rate of interest 1 0.06 1 0.06 3 real rate of interest
You might0.04 ask yourself, 5 1.06“As
3 reallong
rate of as I’m not breaking society’s laws, why should I
essential ingredient in the building- M02_KEOW3285_09_SE_C02.indd 41
interest
care about ethics?” The answer to this question lies in consequences. Everyone makes
28/11/15 2:54 PM
block approach to the material that Solving for the real rate of interest:
errors of judgment in business, which is to be expected in an uncertain world. But ethi-
Real rate of interest 5 0.0377 5 3.77%
we use. cal errors are different. Even if they don’t result in anyone going to jail, they tend to end
careers and thereby terminate future opportunities. Why? Because unethical behavior
destroys trust, and businesses cannot
the following function(which
relationship without a certain
comes degree
from equation of trust.
(2-2)), an approximation
method, to estimate the real rate of interest over a selected past time frame.
Concept Check Concept Check

Nominal interest rate 2 inflation rate > real interest rate
The concept is straightforward, but its implementation requires that several judg-
At the end of major chapter sections 1. According to Principlements be made.
3, how For example,
do investors suppose
decide wherewe want to usetheir
to invest this relationship
money? to determine
the real risk-free interest rate. Which interest rate series and maturity period should
2. What is an efficient market?
we include a brief list of questions be used? Suppose we settle for using some U.S. Treasury security as a surrogate for a
3. What is the agency problem,
nominal and whyinterest
risk-free does itrate.
occur?
Then, should we use the yield on 3-month U.S.
that are designed to highlight key Treasury
4. Why are ethics and trust bills or, in
important perhaps, the yield on 30-year Treasury bonds? There is no absolute
business?
answer to the question.
ideas presented in the section. So, we can have a real risk-free short-term interest rate, as well as a real risk-free
long-term interest rate, and several variations in between. In essence, it just depends
on what the analyst wants to accomplish. Of course we could also calculate the real
The Role of Finance in Business

rate of interest on some rating class of 30-year corporate bonds (such as Aaa-rated
bonds) and have a risky real rate of interest as opposed to a real risk-free interest rate.
LO3 Describe the role of Furthermore, the choice of a proper inflation index is equally challenging. Again,
finance in business. Finance is the study of we how havepeople
several choices. We could use evaluate
and businesses the consumer price index, theand
investments producer
raise price
index for finished goods, or some price index out of the national income accounts,
capital to fund them. Our suchinterpretation of an
as the gross domestic investment
product chain priceisindex.
quiteAgain,
broad.thereWhen Apple
is no precise scien-
designed its Apple Watch, it wasas clearly
tific answer making
to which specific a index
price long-term investment.
to use. Logic Thedofirm
and consistency narrow
had to devote considerablethe boundaries
expenses of theto
ultimate choice. producing, and marketing the
designing,
Let’s tackle a very basic (simple) example. Suppose that an analyst wants to esti-
Concept 20
xxii PrefaceCheck
1. How is a company’s return on equity related to the firm’s operating return on assets?
2. How is a company’s return on equity related to the firm’s debt ratio?
3. What is the upside of debt financing? What is the downside?
Financial Decision Tools

F I NA N C IA L D E C IS IO N TO O L S A feature that has proven popular with students
Name of Tool Formula
MyFinanceLab
What It Tells You
Video has been our recapping of key equations shortly
net income Measures the shareholders’ accounting return on after their discussion. Students get to see an equa-
Return on equity
total common equity their investment. tion within the context of related equations.
CALCULATOR SOLUTION Financial Calculators

Data Input Function Key and Excel Spreadsheets
02/12/15 2:00 PM
(5-2) 10 N The use of financial calculators and Excel

6 I/Y spreadsheets has been integrated throughout
- 500 FV the text, especially with respect to presenta-
0 PMT tion of the time value of money and valua-
Function Key Answer tion. Where appropriate, actual calculator and
CPT
spreadsheet solutions appear in the text.
PV 279.20
Chapter Summaries That Bring Together Concepts,

Terminology, and Applications
The chapter summaries have been written in a way that connects them to the in-
chapter sections and learning objectives. For each learning objective, the student sees
in one place the concepts, new terminology, and key equations that were presented
in the objective.
MyFinanceLab Video
Revised Study Problems
With each edition, we have provided new and revised end-of-chapter study prob-
lems to refresh their usefulness in teaching finance. Also, the study problems con-
tinue to be organized according to learning objective so that both the instructor and
student can readily align text and problem materials.
CHAPTER 2 • The Financial Markets and Interest Rates 53
Mini Case
Comprehensive Mini Cases
This Mini Case is available in MyFinanceLab. A comprehensive Mini Case appears at the end of almost
On the first day of your summer internship, you’ve been assigned to work with the
chief financial officer (CFO) of SanBlas Jewels Inc. Not knowing how well trained
every chapter, covering all the major topics included in
you are, the CFO has decided to test your understanding of interest rates. Specifi- that chapter.
02/12/15 2:11 PMEach Mini Case can be used as a lecture or
cally, she asks you to provide a reasonable estimate of the nominal interest rate for
a new issue of Aaa-rated bonds to be offered by SanBlas Jewels Inc. The final format review tool by the professor. For the students, the Mini
that the chief financial officer of SanBlas Jewels has requested is that of equation (2-1)
in the text. Your assignment also requires that you consult the data in Table 2-2.
Case provides an opportunity to apply all the concepts
Some agreed-upon procedures related to generating estimates for key variables presented within the chapter in a realistic setting, thereby
in equation (2-1) follow.
a. The current 3-month Treasury bill rate is 2.96 percent, the 30-year Treasury
strengthening their understanding of the material.
bond rate is 5.43 percent, the 30-year Aaa-rated corporate bond rate is 6.71
percent, and the inflation rate is 2.33 percent.
b. The real risk-free rate of interest is the difference between the calculated aver-
age yield on 3-month Treasury bills and the inflation rate.
c. The default-risk premium is estimated by the difference between the average
yields on Aaa-rated bonds and 30-year Treasury bonds.
d. The maturity-risk premium is estimated by the difference between the average
yields on 30-year Treasury bonds and 3-month Treasury bills.
e. SanBlas Jewels’ bonds will be traded on the New York Bond Exchange, so the
liquidity-risk premium will be slight. It will be greater than zero, however,
because the secondary market for the firm’s bonds is more uncertain than that
of some other jewel sellers. It is estimated at 4 basis points. A basis point is one
one-hundredth of 1 percent.
Now place your output into the format of equation (2-1) so that the nominal interest
rate can be estimated and the size of each variable can also be inspected for reason-
ableness and discussion with the CFO.
Preface xxiii
A Complete Support Package for the

Student and Instructor
MyFinanceLab
This fully integrated online homework system gives students the hands-on prac-
tice and tutorial help they need to learn finance efficiently. Ample opportunities for
online practice and assessment in MyFinanceLab are seamlessly integrated into each
chapter. For more details, see the inside front cover.
Instructor’s Resource Center

This password-protected site, accessible at http://www.pearsonhighered.com/irc,
hosts all of the instructor resources that follow. Instructors should click on the “IRC
Help Center” link for easy-to-follow instructions on getting access or may contact
their sales representative for further information.
Test Bank
This online Test Bank, prepared by Rodrigo Hernandez of Radford University, pro-
vides more than 1,600 multiple-choice, true/false, and short-answer questions with
complete and detailed answers. The online Test Bank is designed for use with the
TestGen-EQ test-generating software. This computerized package allows instruc-
tors to custom design, save, and generate classroom tests. The test program permits
instructors to edit, add, or delete questions from the Test Bank; analyze test results;
and organize a database of tests and student results. This software allows for greater
flexibility and ease of use. It provides many options for organizing and displaying
tests, along with a search and sort feature.
Instructor’s Manual with Solutions

Written by the authors and updated by Mary Schranz, the Instructor’s Manual fol-
lows the textbook’s organization and represents a continued effort to serve the teach-
er’s goal of being effective in the classroom. Each chapter contains a chapter orienta-
tion, answers to end-of-chapter review questions, and solutions to end-of-chapter
study problems.
The Instructor’s Manual is available electronically, and instructors can download
it from the Instructor’s Resource Center by visiting http://www.pearsonhighered.
com/irc.
The PowerPoint Lecture Presentation

This lecture presentation tool, prepared by Sonya Britt of Kansas State University,
provides the instructor with individual lecture outlines to accompany the text. The
slides include many of the figures and tables from the text. These lecture notes can
be used as is, or instructors can easily modify them to reflect specific presentation
needs.
Excel Spreadsheets
Created by the authors, these spreadsheets correspond to end-of-chapter problems
from the text. This student resource is available on MyFinanceLab.
xxiv Preface
Acknowledgments
We gratefully acknowledge the assistance, support, and encouragement of those indi-
viduals who have contributed to Foundations of Finance. Specifically, we wish to rec-
ognize the very helpful insights provided by many of our colleagues. For this edition,
we are especially grateful to Mary Schranz, formerly of the University of Wisconsin,
Madison, who performed an incredibly detailed accuracy review. We are also
indebted to many other professionals for their careful reviews and helpful comments:
Haseeb Ahmed, Johnson C. Smith Dr. Charles Gahala, Benedictine
University University
Joan Anderssen, Arapahoe Harry Gallatin, Indiana State
Community College University
Chris Armstrong, Draughons Junior Deborah Giarusso, University of
College Northern Iowa
Curtis Bacon, Southern Oregon Gregory Goussak, University of
University Nevada, Las Vegas
Deb Bauer, University of Oregon Lori Grady, Bucks County
Pat Bernson, County College of Community College
Morris Ed Graham, University of North
Ed Boyer, Temple University Carolina, Wilmington
Joe Brocato, Tarleton State Barry Greenberg, Webster
University University
Joseph Brum, Fayetteville Technical Gary Greer, University of Houston
Community College Downtown
Lawrence Byerly, Thomas More Indra Guertler, Simmons College
College Bruce Hadburg, University of Tampa
Juan R. Castro, LeTourneau Thomas Hiebert, University of
University North Carolina, Charlotte
Janice Caudill, Auburn University Marlin Jensen, Auburn University
Ting-Heng Chu, East Tennessee John Kachurick, Misericordia
State University University
David Daglio, Newbury College Okan Kavuncu, University of
Julie Dahlquist, University of Texas California at Santa Cruz
at San Antonio Gary Kayakachoian, The University
David Darst, Central Ohio Technical of Rhode Island
College David F. Kern, Arkansas State
Maria de Boyrie, New Mexico State University
University Brian Kluger, University of
Kate Demarest, Carroll Community Cincinnati
College Lynn Phillips Kugele, University of
Khaled Elkhal, University of Mississippi
Southern Indiana Mary LaPann, Adirondack
Cheri Etling, University of Tampa Community College
Robert W. Everett, Lock Haven Carlos Liard-Muriente, Central
University Connecticut State University
Cheryl Fetterman, Cape Fear Christopher Liberty, College of Saint
Community College Rose, Empire State College
David R. Fewings, Western Lynda Livingston, University of
Washington University Puget Sound
Preface xxv
Y. Lal Mahajan, Monmouth Ahmad Salam, Widener University

University Mary Schranz, University of
Edmund Mantell, Pace University Wisconsin, Madison (retired)
Peter Marks, Rhode Island College Jeffrey Schultz, Christian Brothers
Mario Mastrandrea, Cleveland University
State University Thomas W. Secrest, Coastal
Anna McAleer, Arcadia University Carolina University
Robert Meyer, Parkland College Ken Shakoori, California State
University, Bakersfield
Ronald Moy, St. John’s University
Michael Slates, Bowling Green
Elisa Muresan, Long Island
State University
University
Suresh Srivastava, University of
Michael Nugent, Stony Brook
Alaska, Anchorage
University
Maurry Tamarkin, Clark University
Tony Plath, University of North
Carolina at Charlotte Fang Wang, West Virginia
University
Anthony Pondillo, Siena College
Paul Warrick, Westwood College
Walter Purvis, Coastal Carolina
Community College Jill Wetmore, Saginaw Valley State
University
Emil Radosevich, Central New
Mexico Community College Kevin Yost, Auburn University
Deana Ray, Forsyth Technical Jingxue Yuan, Texas Tech
Community College University
Clarence Rose, Radford University Mengxin Zhao, Bentley College
We also thank our friends at Pearson. They are a great group of folks. We offer
our personal expression of appreciation to Vice President of Business Publishing
Donna Battista, who provided the leadership and direction to this project. She is the
best, and she settles for nothing less than perfection—thanks, Donna. We would also
like to thank Kate Fernandes, our finance editor. Kate is full of energy and drive
with amazing insights and intuition about what makes a great book. Additionally,
Kathryn Dinovo, our program manager, helped us develop new technology—videos
and animations—for this edition. We would also like to thank Meredith Gertz, our
project manager, who guided us through the writing and production processes.
Meredith kept us on schedule while maintaining extremely high quality. Our thanks
also go to Heidi Allgair of Cenveo Publisher Services, who served as the project man-
ager and did a superb job. Even more, she was fun to work with, always keeping us
on task. Miguel Leonarte, who worked on MyFinanceLab, also deserves a word of
thanks for making MyFinanceLab flow so seamlessly with the book. He has contin-
ued to refine and improve MyFinanceLab, and as a result of his efforts, it has become
a learning tool without equal. We also thank Melissa Honig, our media producer,
who did a great job of making sure we are on the cutting edge in terms of Web appli-
cations and offerings.
As a final word, we express our sincere thanks to those who are using Foundations
of Finance in the classroom. We thank you for making us a part of your teaching–
learning team. Please feel free to contact any member of the author team should you
have questions or needs.
—A.J.K. / J.D.M. / J.W.P.

An Introduction to
1
CHAPTER
the Foundations of
Financial Management
Learning Objectives
LO1 Identify the goal of the firm. The Goal of the Firm
LO2 Understand the basic principles of finance, Five Principles That Form the
their importance, and the importance of ethics Foundations of Finance
and trust.
LO3 Describe the role of finance in business. The Role of Finance in Business
LO4 Distinguish among the different legal forms The Legal Forms of Business
of business organization. Organization
LO5 Explain what has led to the era of the multi- Finance and the Multinational
national corporation. Firm: The New Role
A
pple Computer (AAPL) ignited the personal computer revolution in the
1970s with the Apple II and reinvented the personal computer in the 1980s
with the Macintosh. But by 1997, it looked like it might be nearing the end
for Apple. Mac users were on the decline, and the company didn’t seem to be headed
in any real direction. It was at that point that Steve Jobs reappeared, taking back his
old job as CEO of Apple, the company he cofounded in 1976. To say the least, things
began to change. In fact, 18 years later, in 2015, the price of Apple’s common stock
climbed by 225-fold!
How did Apple accomplish this? The company did it by going back to what it does
best, which is to produce products that make the optimal trade-off among ease of
use, complexity, and features. Apple took its special skills and applied them to more
than just computers, introducing new products such as the iPod, iTunes, the sleek
iMac, the MacBook Air, the iPod Touch, and the iPhone along with its unlimited
“apps.” Although all these products have done well, the success of the iPod has been
truly amazing. Between the introduction of the iPod in October 2001 and the begin-
ning of 2005, Apple sold more than 6 million of the devices. Then, in 2004, it came
out with the iPod Mini, about the length and width of a business card, which has also
2
been a huge success, particularly among
women. How successful has this new
product been? By 2004, Apple was selling
more iPods than its signature Macintosh
desktop and notebook computers.
How do you follow up on the success
of the iPod? You keep improving your
products, and you keep developing and
introducing new products that consum-
ers want—the iPhone. With this in mind,
in October 2014, Apple unveiled its
iPhone 6 and 6 Plus, selling over 10 mil-
lion phones in the first week. In effect,
Apple seems to have a never-ending sup-
ply of new, exciting products that we all
want. Then in April 2015, Apple introduced the Apple Watch, and it is now consider-
ing introducing an Apple Car by 2020.
How did Apple make the decision to introduce the original iPod and now the
iPad? The answer is by identifying a customer need, combined with sound financial
management. Financial management deals with the maintenance and creation of
economic value or wealth by focusing on decision making with an eye toward creat-
ing wealth. This text deals with financial decisions such as when to introduce a new
product, when to invest in new assets, when to replace existing assets, when to bor-
row from banks, when to sell stocks or bonds, when to extend credit to a customer,
and how much cash and inventory to maintain. All of these aspects of financial man-
agement were factors in Apple’s decision to introduce and continuously improve the
iPod, iPhone, and iPad, and the end result is having a major financial impact on Apple.
In this chapter, we lay the foundation for the entire book by explaining the key
goal that guides financial decision making: maximizing shareholder wealth. From
there we introduce the thread that ties everything together: the five basic principles
of finance. Finally, we discuss the legal forms of business. We close the chapter with a
brief look at what has led to the rise in multinational corporations.
The Goal of the Firm LO1 Identify the goal of the

firm.
The fundamental goal of a business is to create value for the company’s owners (i.e.,
its shareholders). This goal is frequently stated as “maximization of shareholder
wealth.” Thus, the goal of the financial manager is to create wealth for the sharehold-
ers by making decisions that will maximize the price of the existing common stock.
Not only does this goal directly benefit the shareholders of the company, but it also
provides benefits to society as scarce resources are directed to their most productive
use by businesses competing to create wealth.
We have chosen maximization of shareholder wealth—that is, maximizing the
market value of the existing shareholders’ common stock—because all financial deci-
sions ultimately affect the firm’s stock price. Investors react to poor investment or
dividend decisions by causing the total value of the firm’s stock to fall, and they react
to good decisions by pushing up the price of the stock. In effect, under this goal,
good decisions are those that create wealth for the shareholder.
3
4 PART 1 • The Scope and Environment of Financial Management
Obviously, some serious practical problems arise when we use changes in the
value of the firm’s stock to evaluate financial decisions. Many things affect stock
prices; to attempt to identify a reaction to a particular financial decision would sim-
ply be impossible, but fortunately that is unnecessary. To employ this goal, we need
not consider every stock price change to be a market interpretation of the worth of
our decisions. Other factors, such as changes in the economy, also affect stock prices.
What we do focus on is the effect that our decision should have on the stock price if
everything else were held constant. The market price of the firm’s stock reflects the
value of the firm as seen by its owners and takes into account the complexities and
complications of the real-world risk. As we follow this goal throughout our discus-
sions, we must keep in mind one more question: Who exactly are the shareholders?
The answer: Shareholders are the legal owners of the firm.
Concept Check
1. What is the goal of the firm?
2. How would you apply this goal in practice?
LO2 Understand the basic

principles of finance,
Five Principles That Form the Foundations
their importance, and the
importance of ethics and trust.
of Finance
To the first-time student of finance, the subject matter may seem like a collection of
unrelated decision rules. This impression could not be further from the truth. In fact,
our decision rules, and the logic that underlies them, spring from five simple princi-
ples that do not require knowledge of finance to understand. These five principles
guide the financial manager in the creation of value for the firm’s owners (the stock-
holders).
As you will see, although it is not necessary to understand finance to understand
these principles, it is necessary to understand these principles in order to understand
finance. These principles may at first appear simple or even trivial, but they provide
the driving force behind all that follows, weaving together the concepts and tech-
niques presented in this text, and thereby allowing us to focus on the logic underly-
ing the practice of financial management. Now let’s introduce the five principles.
PRINCIPLE
Principle 1: Cash Flow Is What Matters
1
You probably recall from your accounting classes that a company’s profits can differ
dramatically from its cash flows, which we will review in Chapter 3. But for now
understand that cash flows, not profits, represent money that can be spent.
Consequently, it is cash flow, not profits, that determines the value of a business. For
this reason when we analyze the consequences of a managerial decision, we focus on
the resulting cash flows, not profits.
In the movie industry, there is a big difference between accounting profits and
cash flow. Many a movie is crowned a success and brings in plenty of cash flow for
the studio but doesn’t produce a profit. Even some of the most successful box office
hits—Forrest Gump, Coming to America, Batman, My Big Fat Greek Wedding, and the TV
series Babylon 5—realized no accounting profits at all after accounting for various
movie studio costs. That’s because “Hollywood Accounting” allows for overhead
costs not associated with the movie to be added on to the true cost of the movie. In
fact, the movie Harry Potter and the Order of the Phoenix, which grossed almost $1 bil-
lion worldwide, actually lost $167 million according to the accountants. Was Harry
Potter and the Order of the Phoenix a successful movie? It certainly was—in fact, it was
the 27th highest grossing film of all time. Without question, it produced cash, but it
didn’t make any profits.
CHAPTER 1 • An Introduction to the Foundations of Financial Management 5
We need to make another important point about cash flows. Recall from your
economics classes that we should always look at marginal, or incremental, cash incremental cash flow the difference
flows when making a financial decision. The incremental cash flow to the company between the cash flows a company will
produce both with and without the
as a whole is the difference between the cash flows the company will produce both with and investment it is thinking about making.
without the investment it’s thinking about making. To understand this concept, let’s think
about the incremental cash flows of the movie Frozen. Not only did Disney make
money on this movie, but it also made an awful lot of money on merchandise from
the movie. While Anna and Elsa pulled in an incredible $1.3 billion at the box office,
sales of Frozen toys, clothing, and games along with the soundtrack brought in about
that same amount. With a Broadway version under development and the possibility
of a sequel under way, Disney is going to be singing “Let It Go” all the way to the
bank.
Principle 2: Money Has a Time Value PRINCIPLE
2
Perhaps the most fundamental principle of finance is that money has a “time” value.
Very simply, a dollar received today is more valuable than a dollar received one year
from now because we can invest the dollar we have today to earn interest so that at
the end of one year we will have more than one dollar.
For example, suppose you have a choice of receiving $1,000 either today or one
year from now. If you decide to receive it a year from now, you will have passed up
the opportunity to earn a year’s interest on the money. Economists would say you
suffered an “opportunity loss” or an “opportunity cost.” The cost is the interest you
could have earned on the $1,000 if you had invested it for one year. The concept of
opportunity costs is fundamental to the study of finance and economics. Very simply,
the opportunity cost of any choice you make is the highest-valued alternative that you opportunity cost the cost of making
had to give up when you made the choice. So if you loan money to your brother at no a choice in terms of the next best
alternative that must be foregone.
interest, money that otherwise would have been loaned to a friend (who is equally
likely to repay you) for 8 percent interest, then the opportunity cost of making the
loan to your brother is 8 percent.
In the study of finance, we focus on the creation and measurement of value. To
measure value, we use the concept of the time value of money to bring the future
benefits and costs of a project, measured by its cash flows, back to the present. Then,
if the benefits or cash inflows outweigh the costs, the project creates wealth and
should be accepted; if the costs or cash outflows outweigh the benefits or cash
inflows, the project destroys wealth and should be rejected. Without recognizing the
existence of the time value of money, it is impossible to evaluate projects with future
benefits and costs in a meaningful way.
Principle 3: Risk Requires a Reward PRINCIPLE
3
Even the novice investor knows there are an unlimited number of investment alter-
natives to consider. But without exception, investors will not invest if they do not
expect to receive a return on their investment. They will want a return that satisfies
two requirements:
◆ A return for delaying consumption. Why would anyone make an investment that
would not at least pay them something for delaying consumption? They won’t—
even if there is no risk. In fact, investors will want to receive at least the same
return that is available for risk-free investments, such as the rate of return being
earned on U.S. government securities.
◆ An additional return for taking on risk. Investors generally don’t like risk. Thus,
risky investments are less attractive—unless they offer the prospect of higher
returns. That said, the more unsure people are about how an investment will per-
form, the higher the return they will demand for making that investment. So, if
you are trying to persuade investors to put money into a risky venture you are
pursuing, you will have to offer them a higher expected rate of return.
FIGURE 1-1 The Risk–Return Trade-off
Expected return
Additional
expected return
for taking on
added risk
Expected return
for delaying
consumption
Risk
Figure 1-1 depicts the basic notion that an investor’s rate of return should equal
a rate of return for delaying consumption plus an additional return for assuming
risk. For example, if you have $5,000 to invest and are considering either buying
stock in Apple (AAPL) or investing in a new biotech startup firm that has no past
record of success, you would want the startup investment to offer the prospect of
a higher expected rate of return than the investment in an established company
like Apple.
Notice that we keep referring to the expected return rather than the actual return.
As investors, we have expectations about what returns our investments will earn.
However, we can’t know for certain what they will be. For example, if investors could
have seen into the future, no one would have bought stock in Vascular Biogenics
(VBLT), an Israeli-based clinical-stage biopharmaceutical company, on February 19,
2015. Why? Because on that day the company reported that Phase 2 trials of one of its
drugs aimed at psoriasis and ulcerative colitis failed to meet its primary endpoints.
The result was that, within minutes of the announcement, the company’s stock price
dropped by a whopping 65 percent.
The risk–return relationship will be a key concept as we value stocks, bonds, and
proposed new investment projects throughout this text. We will also spend some
time determining how to measure risk. Interestingly, much of the work for which the
1990 Nobel Prize for economics was awarded centered on the relationship depicted
in the graph in Figure 1-1 and how to measure risk. Both the graph and the risk–
return relationship it depicts will reappear often in our study of finance.
PRINCIPLE
Principle 4: Market Prices Are Generally Right
4
To understand how securities such as bonds and stocks are valued or priced in the
financial markets, it is necessary to understand the concept of an efficient market. An
efficient market a market in which efficient market is one in which the prices of the assets traded in that market fully reflect
the prices of securities at any instant in all available information at any instant in time.
time fully reflect all publicly available
information about the securities and Security markets such as the stock and bond markets are particularly important
their actual public values. to our study of finance because these markets are the place where firms can go to
raise money to finance their investments. Whether a security market such as the
New York Stock Exchange (NYSE) is efficient depends on the speed with which
newly released information is impounded into prices. Specifically, an efficient stock
market is characterized by a large number of profit-driven individuals who act very
quickly by buying (or selling) shares of stock in response to the release of new
information.
If you are wondering just how vigilant investors in the stock market are in
watching for good and bad news, consider the following set of events. While Nike
(NKE) CEO William Perez flew aboard the company’s Gulfstream jet one day in
November 2005, traders on the ground sold off a significant amount of Nike’s
stock. Why? Because the plane’s landing gear was malfunctioning, and they were
watching TV coverage of the event! Before Perez landed safely, Nike’s stock
dropped 1.4 percent. Once Perez’s plane landed, Nike’s stock price immediately
bounced back. This example illustrates that in the financial market there are ever-
vigilant investors who are looking to act even in the anticipation of the release of
new information.
Another example of the speed with which stock prices react to new information
deals with Disney. Beginning with Toy Story in 1995, Disney (DIS) was on a roll, mak-
ing one hit after another, including Monsters, Inc., Finding Nemo, the Pirates of the
Caribbean series, The Incredibles, the Ironman series, and Frozen. In spite of all this suc-
cess, in 2014, the hopes for Guardians of the Galaxy, based on a relatively unknown
Marvel comic book series starring a tree and a talking raccoon among other charac-
ters, weren’t very high. However, the movie’s opening weekend receipts were amaz-
ing: While it was projected to gross less than $70 million worldwide, it actually
grossed over $160 million and became the top grossing movie of 2014. How did the
stock market respond to the unexpected box office reaction during the movie’s open-
ing weekend? On the Monday following the opening weekend, Disney stock opened
over 2 percent higher. Apparently, the news of the surprisingly strong box office
receipts was reflected in Disney’s opening stock price, even before it traded! The
same speed in the market reaction to new information also happened on February
25, 2015, when it was learned that 60 Minutes would air a potentially damaging story
on Lumber Liquidators later that week. As a result, Lumber Liquidators’ stock price
dropped by 25 percent even before anyone knew what the story was going to be
about—in effect, it dropped before the news. After the 60 Minutes report that out-
lined health and safety concerns with its laminated flooring actually aired on Sunday
evening, Lumber Liquidators opened another 25 percent down.
The key learning point here is the following: Stock market prices are a useful
barometer of the value of a firm. Specifically, managers can expect their company’s
share prices to respond quickly to investors’ assessment of their decisions. On the
one hand, if investors on the whole agree that the decision is a good one that creates
value, then they will push up the price of the firm’s stock to reflect that added value.
On the other hand, if investors feel that a decision is bad for share prices, then the
firm’s share value will be driven down.
Unfortunately, this principle doesn’t always work perfectly in the real world.
You just need to look at the housing price bubble that helped bring on the eco-
nomic downturn in 2008–2009 to realize that prices and value don’t always move
in lockstep. Like it or not, the psychological biases of individuals impact decision
making, and as a result, our decision-making process is not always rational.
Behavioral finance considers this type of behavior and takes what we already know
about financial decision making and adds in human behavior with all its apparent
irrationality.
We’ll try and point out the impact of human behavior on decisions throughout
our study. But understand that the field of behavioral finance is a work in progress—
we understand only a small portion of what may be going on. We can say, however,
that behavioral biases have an impact on our financial decisions. As an example,
people tend to be overconfident and many times mistake luck for skill. As Robert
Shiller, a well-known economics professor at Yale, put it, “people think they know
more than they do.”1 This overconfidence applies to their abilities, their knowledge
and understanding, and forecasting the future. Because they have confidence in their
valuation estimates, they may take on more risk than they should. These behavioral
biases impact everything in finance, ranging from making investment analyses to
analyzing new projects to forecasting the future.
1
See Robert J. Shiller, Irrational Exuberance (New York: Broadway Books, 2000), p. 142.
PRINCIPLE
Principle 5: Conflicts of Interest Cause Agency Problems
5
Throughout this book we will describe how to make financial decisions that increase
the value of a firm’s shares. However, managers do not always follow through
with these decisions. Often they make decisions that actually lead to a decrease in the
value of the firm’s shares. When this happens, it is frequently because the managers’
own interests are best served by ignoring shareholder interests. In other words, there
is a conflict of interest between what is best for the managers and what is best for the
stockholders. For example, shutting down an unprofitable plant may be in the best
interests of the firm’s stockholders, but in so doing the managers will find themselves
out of a job or having to transfer to a different job. This very clear conflict of interest
might lead the management of the plant to continue running the plant at a loss.
agency problem problems and Conflicts of interest lead to what economists describe as an agency cost or
conflicts resulting from the separation agency problem. That is, managers are the agents of the firm’s stockholders (the
of the management and ownership of
the firm. owners), and if the agents do not act in the best interests of their principal, this leads
to an agency cost. Although the goal of the firm is to maximize shareholder value, in
reality the agency problem may interfere with implementation of this goal. The
agency problem results from the separation of the management and ownership of the firm.
For example, a large firm may be run by professional managers or agents who have
little or no ownership in the firm. Because of this separation between decision mak-
ers and owners, managers may make decisions that are not in line with the goal of
maximizing shareholder wealth. They may approach work less energetically and
attempt to benefit themselves in terms of salary and perquisites at the expense of
shareholders.
Managers might also avoid any projects that have risk associated with them—
even if they are great projects with huge potential returns and a small chance of fail-
ure. Why is this so? Because if the project isn’t successful, these agents of the share-
holders may lose their jobs.
Agency problems also contributed to our recent financial crisis, with some mort-
gage brokers being paid to find borrowers. The brokers would then make the loan
and sell the mortgage to someone else. Because they didn’t hold the mortgage but
only created it, they didn’t care about the quality of the mortgage. In effect, they
wrote mortgages when the borrower had a low chance of being able to pay off the
mortgage because they got paid per mortgage and then sold the mortgage to some-
one else almost immediately. There was no incentive to screen for the quality of the
borrower, and as a result both the borrower who was misled into thinking he could
afford the mortgage and the holder of the mortgage were hurt.
The costs associated with the agency problem are difficult to measure, but occa-
sionally we see the problem’s effect in the marketplace. If the market feels manage-
ment is damaging shareholder wealth, removal of that management may cause a
positive reaction in stock price. For example, on the announcement of the death of
Roy Farmer, the CEO of Farmer Brothers (FARM), a seller of coffee-related products,
Farmer Brothers’ stock price rose about 28 percent. Generally, the tragic loss of a
company’s top executive raises concerns over a leadership void, causing the share
price to drop; in the case of Farmer Brothers, however, investors thought a change in
management would have a positive impact on the company.
If the firm’s management works for the owners, who are the shareholders, why
doesn’t the management get fired if it doesn’t act in the shareholders’ best interest?
In theory, the shareholders pick the corporate board of directors, and the board of
directors in turn picks the management. Unfortunately, in reality the system fre-
quently works the other way around. Management selects the board of director
nominees and then distributes the ballots. In effect, shareholders are generally
offered a slate of nominees selected by the management. The end result is that man-
agement effectively selects the directors, who then may have more allegiance to
managers than to shareholders. This, in turn, sets up the potential for agency prob-
lems, with the board of directors not monitoring managers on behalf of the share-
holders as it should.
The root cause of agency problems is conflict of interest. Whenever such conflicts
exist in business, individuals may do what is in their own rather than the organiza-
tion’s best interests. For example, in 2000 Edgerrin James was a running back for the
Indianapolis Colts and was told by his coach to get a first down and then fall down.
That way the Colts wouldn’t be accused of running up the score against a team they
were already beating badly. However, since James’s contract included incentive pay-
ments associated with rushing yards and touchdowns, he acted in his own self-
interest and ran for a touchdown on the very next play.
We will spend considerable time discussing monitoring managers and the meth-
ods used to align their interests with those of shareholders. As an example, managers
can be monitored by rating agencies and by auditing financial statements, and com-
pensation packages may be used to align the interests of managers and shareholders.
Additionally, the interests of managers and shareholders can be aligned by establish-
ing management stock options, bonuses, and perquisites that are directly tied to how
closely managers’ decisions coincide with the interests of shareholders. In other
words, what is good for shareholders must also be good for managers. If that is not
the case, managers will make decisions in their best interest rather than maximizing
shareholder wealth.
The Global Financial Crisis

Beginning in 2007, the United States experienced its most severe financial crisis since
the Great Depression of the 1930s. As a result, some financial institutions collapsed
while the government bailed others out, unemployment skyrocketed, the stock
market plummeted, and the United States entered into a recession. Although the
recession is now officially over, many Americans still feel the lingering effects of the
financial crisis from lost wages resulting from high unemployment, along with a dra-
matic rise in our country’s debt. Europe also faced a financial crisis of its own. Many
members of the European Union (EU) experienced severe budget problems, includ-
ing Greece, Italy, Ireland, Portugal, and Spain. These nations have all had problems
balancing their budgets and repaying their government loans.
Although many factors contributed to the financial crisis, the most immediate
cause has been attributed to the collapse of the real estate market in the United States
and the resulting real estate loan (mortgage) defaults. The focus of the loan defaults
has been on what are commonly referred to as subprime loans. These are loans made
to borrowers whose ability to repay them is highly doubtful. When the market for
real estate began to falter in 2006, many of the homebuyers with subprime mortgages
began to default. As the economy contracted during the recession, people lost their
jobs and could no longer make their mortgage loan payments, resulting in even more
defaults.
To complicate the problem, most real estate mortgages were packaged in portfo-
lios and resold to investors around the world. This process of packaging mortgages
is called securitization. Basically, securitization is a very useful tool for increasing the
supply of new money that can be lent to new homebuyers. Here’s how mortgages
are securitized: First, homebuyers borrow money by taking out a mortgage to
finance a home purchase. The lender, generally a bank, savings and loan, or mort-
gage broker that made the loan, then sells the mortgage to another firm or financial
institution that pools together a portfolio of many different mortgages. The purchase
of the pool of mortgages is financed through the sale of securities (called mortgage-
backed securities, or MBS) that are sold to investors who can hold them as an invest-
ment or resell them to other investors. This process allows the mortgage bank or
other financial institution that made the original mortgage loan to get its money
back out of the loan and lend it to someone else. Thus, securitization provides liquid-
ity to the mortgage market and makes it possible for banks to loan more money to
homebuyers.
Okay, so what’s the catch? As long as lenders properly screen the mortgages to
make sure the borrowers are willing and able to repay their home loans and real
estate values remain higher than the amount owed, everything works fine.
However, if lenders make loans to individuals who really cannot afford to make the
payments and real estate prices drop precipitously, as they began to do in 2006,
problems will arise and many mortgages (especially those in which the amount of
the loan was a very high percentage of the property value) will be “under water.”
That is, the homeowner will owe more than the home is worth. When this occurs
homeowners may start to default on their mortgage loans. This is especially true
when the economy goes into a recession and people lose their jobs and, correspond-
ingly, the ability to make their mortgage payments. This was the scenario in 2006.
In essence, 2006 brought a perfect storm of bad loans, falling housing prices, and a
contracting economy.
Where are we now? As of this writing, in 2015, the recession is officially over,
having ended in 2009; however, despite this pronouncement there is evidence that
the economy is still not back to normal. Although the unemployment rate has
gone down, the unemployment rate may not accurately reflect those job seekers
who have given up and are no longer seeking employment, and it may not reflect
what has become known as underemployment, whereby individuals are taking
jobs but these jobs do not take advantage of the individuals’ employment creden-
tials (for example, college professors driving taxi cabs). Europe still faces economic
problems of its own, with Greece’s economy in crisis with an unemployment rate
over 25 percent, while unemployment in Spain and Italy is topping 22 percent and
12 percent, respectively.
Avoiding Financial Crisis—Back to the Principles

Four significant economic events that have occurred during the last decade all point
to the importance of keeping our eye closely affixed to the five principles of finance:
the dot-com bubble; the accounting scandals headlined by Enron, WorldCom, and
Bernie Madoff; the housing bubble; and, finally, the recent economic crisis.
Specifically, the problems that firms encounter in times of crisis are often brought on
and made worse by not paying close attention to the foundational principles of
finance. To illustrate, consider the following:
◆ Forgetting Principle 1: Cash Flow Is What Matters (Focusing on earnings instead

of cash flow). The financial fraud committed by Bernie Madoff, WorldCom, and
others at the turn of the 21st century was a direct result of managerial efforts to
manage the firm’s reported earnings to the detriment of the firm’s cash flows. The
belief in the importance of current period earnings as the most critical determi-
nant of the market valuation of the firm’s shares led some firms to sacrifice future
cash flows in order to maintain the illusion of high and growing earnings.
◆ Forgetting Principle 2: Money Has a Time Value (Focusing on the short run).
When trying to put in place a system that would align the interests of managers
and shareholders, many firms tied managerial compensation to short-run perfor-
mance. Consequently, in many firms the focus shifted from what was best in the
long run to what was best in the short run.
◆ Forgetting Principle 3: Risk Requires a Reward (Excessive risk taking due to
underestimation of risk). Relying on historical evidence, managers often under-
estimated the real risks that their decisions entailed. This underestimation of the
underlying riskiness of their decisions led managers to borrow excessively. This
excessive use of borrowed money (or financial leverage) led to financial disaster
and bankruptcy for many firms as the economy slipped into recession. Moreover,
the financial crisis was exacerbated by the fact that often companies simply didn’t
understand how much risk they were taking on. For example, AIG, the giant
insurance company that the government bailed out, was involved in investments
whose value is based on the price of oil in 50 years. Let’s face it, no one knows
what the price of oil will be in a half a century—being involved in this type of
investment is blind risk.
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and literary people, at the same time, to regard him as a complete
imbecile.
“What I fail to understand,” resumed the Duchess, “is how in the
world Robert ever came to fall in love with her. Oh, of course I know
one mustn’t discuss that sort of thing,” she added, with the charming
pout of a philosopher and sentimentalist whose last illusion had long
been shattered. “I know that anybody may fall in love with anybody
else. And,” she went on, for, though she might still laugh at modern
literature, it, either by its dissemination through the popular press or
else in the course of conversation, had begun to percolate into her
mind, “that is the really nice thing about love, because it’s what
makes it so ‘mysterious’.”
“Mysterious! Oh, I must confess, cousin, that’s a bit beyond me,”
said the Comte d’Argencourt.
“Oh dear, yes, it’s a very mysterious thing, love,” declared the
Duchess, with the sweet smile of a good-natured woman of the
world, but also with the rooted conviction with which a Wagnerian
assures a bored gentleman from the Club that there is something
more than just noise in the Walküre. “After all, one never does know
what makes one person fall in love with another; it may not be at all
what we think,” she added with a smile, repudiating at once by this
interpretation the idea she had just suggested. “After all, one never
knows anything, does one?” she concluded with an air of weary
scepticism. “Besides, one understands, doesn’t one; one simply
can’t explain other people’s choices in love.”
But having laid down this principle she proceeded at once to
abandon it and to criticise Saint-Loup’s choice.
“All the same, don’t you know, it is amazing to me that a man can
find any attraction in a person who’s simply silly.”
Bloch, hearing Saint-Loup’s name mentioned and gathering that
he was in Paris, promptly made a remark about him so outrageous
that everybody was shocked. He was beginning to nourish hatreds,
and one felt that he would stop at nothing to gratify them. Once he
had established the principle that he himself was of great moral
worth and that the sort of people who frequented La Boulie (an
athletic club which he supposed to be highly fashionable) deserved
penal servitude, every blow he could get in against them seemed to
him praiseworthy. He went so far once as to speak of a lawsuit which
he was anxious to bring against one of his La Boulie friends. In the
course of the trial he proposed to give certain evidence which would
be entirely untrue, though the defendant would be unable to impugn
his veracity. In this way Bloch (who, incidentally, never put his plan
into action) counted on baffling and infuriating his antagonist. What
harm could there be in that, since he whom he sought to injure was a
man who thought only of doing the “right thing”, a La Boulie man,
and against people like that any weapon was justified, especially in
the hands of a Saint, such as Bloch himself.
“I say, though, what about Swann?” objected M. d’Argencourt, who
having at last succeeded in understanding the point of his cousin’s
speech, was impressed by her accuracy of observation, and was
racking his brains for instances of men who had fallen in love with
women in whom he himself had seen no attraction.
“Oh, but Swann’s case was quite different,” the Duchess
protested. “It was a great surprise, I admit, because she’s just a well-
meaning idiot, but she was never silly, and she was at one time good
looking.”
“Oh, oh!” muttered Mme. de Villeparisis.
“You never thought so? Surely, she had some charming points,
very fine eyes, good hair, she used to dress, and does still dress
wonderfully. Nowadays, I quite agree, she’s horrible, but she has
been a lovely woman in her time. Not that that made me any less
sorry when Charles married her, because it was so unnecessary.”
The Duchess had not intended to say anything out of the common,
but as M. d’Argencourt began to laugh she repeated these last
words—either because she thought them amusing or because she
thought it nice of him to laugh—and looked up at him with a coaxing
smile, to add the enchantment of her femininity to that of her wit. She
went on: “Yes, really, it wasn’t worth the trouble, was it; still, after all,
she did have some charm and I can quite understand anybody’s
falling in love with her, but if you saw Robert’s girl, I assure you,
you’ld simply die of laughter. Oh, I know somebody’s going to quote
Augier at me: ‘What matters the bottle so long as one gets drunk?’
Well, Robert may have got drunk, all right, but he certainly hasn’t
shewn much taste in his choice of a bottle! First of all, would you
believe that she actually expected me to fit up a staircase right in the
middle of my drawing-room. Oh, a mere nothing—what?—and she
announced that she was going to lie flat on her stomach on the
steps. And then, if you’d heard the things she recited, I only
remember one scene, but I’m sure nobody could imagine anything
like it: it was called the Seven Princesses.”
“Seven Princesses! Dear, dear, what a snob she must be!” cried
M. d’Argencourt. “But, wait a minute, why, I know the whole play. The
author sent a copy to the King, who couldn’t understand a word of it
and called on me to explain it to him.”
“It isn’t by any chance, from the Sar Peladan?” asked the historian
of the Fronde, meaning to make a subtle and topical allusion, but in
so low a tone that his question passed unnoticed.
“So you know the Seven Princesses, do you?” replied the
Duchess. “I congratulate you! I only know one, but she’s quite
enough; I have no wish to make the acquaintance of the other six. If
they are all like the one I’ve seen!”
“What a goose!” I thought to myself. Irritated by the coldness of
her greeting, I found a sort of bitter satisfaction in this proof of her
complete inability to understand Maeterlinck. “To think that’s the
woman I walk miles every morning to see. Really, I’m too kind. Well,
it’s my turn now not to want to see her.” Thus I reasoned with myself;
but my words ran counter to my thoughts; they were purely
conversational words such as we say to ourselves at those moments
when, too much excited to remain quietly alone, we feel the need, for
want of another listener, to talk to ourselves, without meaning what
we say, as we talk to a stranger.
“I can’t tell you what it was like,” the Duchess went on; “you simply
couldn’t help laughing. Not that anyone tried; rather the other way,
I’m sorry to say, for the young person was not at all pleased and
Robert has never really forgiven me. Though I can’t say I’m sorry,
actually, because if it had been a success the lady would perhaps
have come again, and I don’t quite see Marie-Aynard approving of
that.”
This was the name given in the family to Robert’s mother, Mme.
de Marsantes, the widow of Aynard de Saint-Loup, to distinguish her
from her cousin, the Princesse de Guermantes-Bavière, also a
Marie, to whose Christian name her nephews and cousins and
brothers-in-law added, to avoid confusion, either that of her husband
or another of her own, making her Marie-Gilbert or Marie-Hedwige.
“To begin with, there was a sort of rehearsal the night before,
which was a wonderful affair!” went on Mme. de Guermantes in
ironical pursuit of her theme. “Just imagine, she uttered a sentence,
no, not so much, not a quarter of a sentence, and then she stopped;
she didn’t open her mouth—I’m not exaggerating—for a good five
minutes.”
“Oh, I say,” cried M. d’Argencourt.
“With the utmost politeness I took the liberty of hinting to her that
this might seem a little unusual. And she said—I give you her actual
words—‘One ought always to repeat a thing as though one were just
composing it oneself.’ When you think of it, that really is
monumental.”
“But I understood she wasn’t at all bad at reciting poetry,” said one
of the two young men.
“She hasn’t the ghost of a notion what poetry is,” replied Mme. de
Guermantes. “However, I didn’t need to listen to her to tell that. It
was quite enough to see her come in with her lilies. I knew at once
that she couldn’t have any talent when I saw those lilies!”
Everybody laughed.
“I hope, my dear aunt, you aren’t angry with me, over my little joke
the other day about the Queen of Sweden. I’ve come to ask your
forgiveness.”
“Oh, no, I’m not at all angry, I even give you leave to eat at my
table, if you’re hungry.—Come along, M. Valmère, you’re the
daughter of the house,” Mme. de Villeparisis went on to the librarian,
repeating a time-honoured pleasantry.
M. de Guermantes sat upright in the armchair in which he had
come to anchor, his hat on the carpet by his side, and examined with
a satisfied smile the plate of little cakes that was being held out to
him.
“Why, certainly, now that I am beginning to feel at home in this
distinguished company, I will take a sponge-cake; they look
excellent.”
“This gentleman makes you an admirable daughter,” commented
M. d’Argencourt, whom the spirit of imitation prompted to keep Mme.
de Villeparisis’s little joke in circulation.
The librarian handed the plate of cakes to the historian of the
Fronde.
“You perform your functions admirably,” said the latter, startled into
speech, and hoping also to win the sympathy of the crowd. At the
same time he cast a covert glance of connivance at those who had
anticipated him.
“Tell me, my dear aunt,” M. de Guermantes inquired of Mme. de
Villeparisis, “who was that rather good-looking man who was going
out just now as I came in? I must know him, because he gave me a
sweeping bow, but I couldn’t place him at all; you know I never can
remember names, it’s such a nuisance,” he added, in a tone of
satisfaction.
“M. Legrandin.”
“Oh, but Oriane has a cousin whose mother, if I’m not mistaken,
was a Grandin. Yes, I remember quite well, she was a Grandin de
l’Epervier.”
“No,” replied Mme. de Villeparisis, “no relation at all. These are
plain Grandins. Grandins of nothing at all. But they’ld be only too
glad to be Grandins of anything you chose to name. This one has a
sister called Mme. de Cambremer.”
“Why, Basin, you know quite well who’ my aunt means,” cried the
Duchess indignantly. “He’s the brother of that great graminivorous
creature you had the weird idea of sending to call on me the other
day. She stayed a solid hour; I thought I should go mad. But I began
by thinking it was she who was mad when I saw a person I didn’t
know come browsing into the room looking exactly like a cow.”
“Listen, Oriane; she asked me what afternoon you were at home; I
couldn’t very well be rude to her; and besides, you do exaggerate so,
she’s not in the least like a cow,” he added in a plaintive tone, though
not without a quick smiling glance at the audience.
He knew that his wife’s lively wit needed the stimulus of
contradiction, the contradiction of common sense which protests that
one cannot (for instance) mistake a woman seriously for a cow; by
this process Mme. de Guermantes, enlarging upon her original idea,
had been inspired to produce many of her most brilliant sayings. And
the Duke in his innocent fashion helped her, without seeming to do
so, to bring off her effects like, in a railway carriage, the
unacknowledged partner of the three-card player.
“I admit she doesn’t look like a cow, she looks like a dozen,”
exclaimed Mme. de Guermantes. “I assure you, I didn’t know what to
do when I saw a herd of cattle come marching into my drawing-room
in a hat and heard them ask me how I was. I had half a mind to say:
‘Please, herd of cattle, you must be making a mistake, you can’t
possibly know me, because you’re a herd of cattle,’ but after racking
my brains over her I came to the conclusion that your Cambremer
woman must be the Infanta Dorothea, who had said she was coming
to see me one day, and is rather bovine also, so that I was just on
the point of saying: ‘Your Royal Highness’ and using the third person
to a herd of cattle. The cut of her dewlap reminded me rather, too, of
the Queen of Sweden. But this massed attack had been prepared for
by long range artillery fire, according to all the rules of war. For I
don’t know how long before, I was bombarded with her cards; I used
to find them lying about all over the house, on all the tables and
chairs, like prospectuses. I couldn’t think what they were supposed
to be advertising. You saw nothing in the house but ‘Marquis et
Marquise de Cambremer’ with some address or other which I’ve
forgotten; you may be quite sure nothing will ever take me there.”
“But it’s a great distinction to look like a Queen,” said the historian
of the Fronde.
“Gad, sir, Kings and Queens, in these days, don’t amount to
much,” said M. de Guermantes, partly because he liked to be
thought broad-minded and modern, and also so as to not to seem to
attach any importance to his own royal friendships, which he valued
highly.
Bloch and M. de Norpois had returned from the other room and
came towards us.
“Well, sir,” asked Mme. de Villeparisis, “have you been talking to
him about the Dreyfus case?”
M. de Norpois raised his eyes to the ceiling, but with a smile, as
though calling on heaven to witness the monstrosity of the caprices
to which his Dulcinea compelled him to submit. Nevertheless he
spoke to Bloch with great affability of the terrible, perhaps fatal
period through which France was passing. As this presumably meant
that M. de Norpois (to whom Bloch had confessed his belief in the
innocence of Dreyfus) was an ardent anti-Dreyfusard, the
Ambassador’s geniality, his air of tacit admission that his listener was
in the right, of never doubting that they were both of the same
opinion, of being prepared to join forces with him to overthrow the
Government, flattered Bloch’s vanity and aroused his curiosity. What
were the important points which M. de Norpois never specified but
on which he seemed implicitly to affirm that he was in agreement
with Bloch; what opinion, then, did he hold of the case, that could
bring them together? Bloch was all the more astonished at the
mysterious unanimity which seemed to exist between him and M. de
Norpois, in that it was not confined to politics, Mme. de Villeparisis
having spoken at some length to M. de Norpois of Bloch’s literary
work.
“You are not of your age,” the former Ambassador told him, “and I
congratulate you upon that. You are not of this age in which
disinterested work no longer exists, in which writers offer the public
nothing but obscenities or ineptitudes. Efforts such as yours ought to
be encouraged, and would be, if we had a Government.”
Bloch was flattered by this picture of himself swimming alone amid
a universal shipwreck. But here again he would have been glad of
details, would have liked to know what were the ineptitudes to which
M. de Norpois referred. Bloch had the feeling that he was working
along the same lines as plenty of others; he had never supposed
himself to be so exceptional. He returned to the Dreyfus case, but
did not succeed in elucidating M. de Norpois’s own views. He tried to
induce him to speak of the officers whose names were appearing
constantly in the newspapers at that time; they aroused more
curiosity than the politicians who were involved also, because they
were not, like the politicians, well known already, but, wearing a
special garb, emerging from the obscurity of a different kind of life
and a religiously guarded silence, simply stood up and spoke and
disappeared again, like Lohengrin landing from a skiff drawn by a
swan. Bloch had been able, thanks to a Nationalist lawyer of his
acquaintance, to secure admission to several hearings of the Zola
trial. He would arrive there in the morning and stay until the court
rose, with a packet of sandwiches and a flask of coffee, as though
for the final examination for a degree, and this change of routine
stimulating a nervous excitement which the coffee and the emotional
interest of the trial worked up to a climax, he would come out so
enamoured of everything that had happened in court that, in the
evening, as he sat at home, he would long to immerse himself again
in that beautiful dream and would hurry out, to a restaurant
frequented by both parties, in search of friends with whom he would
go over interminably the whole of the day’s proceedings, and make
up, by a supper ordered in an imperious tone which gave him the
illusion of power, for the hunger and exhaustion of a day begun so
early and unbroken by any interval for luncheon. The human mind,
hovering perpetually between the two planes of experience and
imagination, seeks to fathom the ideal life of the people it knows and
to know the people whose life it has had to imagine. To Bloch’s
questions M. de Norpois replied:
“There are two officers involved in the case now being tried of
whom I remember hearing some time ago from a man in whose
judgment I felt great confidence, and who praised them both highly—
I mean M. de Miribel. They are Lieutenant-Colonel Henry and
Lieutenant-Colonel Picquart.”
“But,” exclaimed Bloch, “the divine Athena, daughter of Zeus, has
put in the mind of one the opposite of what is in the mind of the
other. And they are fighting against one another like two lions.
Colonel Picquart had a splendid position in the Army, but his Moira
has led him to the side that was not rightly his. The sword of the
Nationalists will carve his tender flesh, and he will be cast out as
food for the beasts of prey and the birds that wax fat upon the bodies
of men.”
M. de Norpois made no reply.
“What are those two palavering about over there?” M. de
Guermantes asked Mme. de Villeparisis, indicating M. de Norpois
and Bloch.
“The Dreyfus case.”
“The devil they are. By the way, do you know who is a red-hot
supporter of Dreyfus? I give you a thousand guesses. My nephew
Robert! I can tell you that, at the Jockey, when they heard of his
goings on, there was a fine gathering of the clans, a regular hue and
cry. And as he’s coming up for election next week....”
“Of course,” broke in the Duchess, “if they’re all like Gilbert, who
keeps on saying that all the Jews ought to be sent back to
Jerusalem.”
“Indeed; then the Prince de Guermantes is quite of my way of
thinking,” put in M. d’Argencourt.
The Duke made a show of his wife, but did not love her. Extremely
self-centred, he hated to be interrupted, besides he was in the habit,
at home, of treating her brutally. Convulsed with the twofold rage of a
bad husband when his wife speaks to him, and a good talker when
he is not listened to, he stopped short and transfixed the Duchess
with a glare which made everyone feel uncomfortable.
“What makes you think we want to hear about Gilbert and
Jerusalem? It’s nothing to do with that. But,” he went on in a gentler
tone, “you will agree that if one of our family were to be pilled at the
Jockey, especially Robert, whose father was chairman for ten years,
it would be a pretty serious matter. What can you expect, my dear,
it’s got ’em on the raw, those fellows; they’re all over it. I don’t blame
them, either; personally, you know that I have no racial prejudice, all
that sort of thing seems to me out of date, and I do claim to move
with the times; but damn it all, when one goes by the name of
‘Marquis de Saint-Loup’ one isn’t a Dreyfusard; what more can I
say?”
M. de Guermantes uttered the words: “When one goes by the
name of Marquis de Saint-Loup,” with some emphasis. He knew very
well that it was a far greater thing to go by that of Duc de
Guermantes. But if his self-esteem had a tendency to exaggerate if
anything the superiority of the title Duc de Guermantes over all
others, it was perhaps not so much the rules of good taste as the
laws of imagination that urged him thus to attenuate it. Each of us
sees in the brightest colours what he sees at a distance, what he
sees in other people. For the general laws which govern perspective
in imagination apply just as much to dukes as to ordinary mortals.
And not only the laws of imagination, but those of speech. Now,
either of two laws of speech may apply here, one being that which
makes us express ourselves like others of our mental category and
not of our caste. Under this law M. de Guermantes might be, in his
choice of expressions, even when he wished to talk about the
nobility, indebted to the humblest little tradesman, who would have
said: “When one goes by the name of Duc de Guermantes,” whereas
an educated man, a Swann, a Legrandin would not have said it. A
duke may write novels worthy of a grocer, even about life in high
society, titles and pedigrees being of no help to him there, and the
epithet “aristocratic” be earned by the writings of a plebeian. Who
had been, in this instance, the inferior from whom M. de Guermantes
had picked up “when one goes by the name”, he had probably not
the least idea. But another law of speech is that, from time to time,
as there appear and then vanish diseases of which nothing more is
ever heard, there come into being, no one knows how,
spontaneously perhaps or by an accident like that which introduced
into France a certain weed from America, the seeds of which, caught
in the wool of a travelling rug, fell on a railway embankment, forms of
speech which one hears in the same decade on the lips of people
who have not in any way combined together to use them. So, just as
in a certain year I heard Bloch say, referring to himself, that “the
most charming people, the most brilliant, the best known, the most
exclusive had discovered that there was only one man in Paris
whom they felt to be intelligent, pleasant, whom they could not do
without—namely Bloch,” and heard the same phrase used by
countless other young men who did not know him and varied it only
by substituting their own names for his, so I was often to hear this
“when one goes by the name”.
“What can one expect,” the Duke went on, “with the influence he’s
come under; it’s easy to understand.”
“Still it is rather comic,” suggested the Duchess, “when you think of
his mother’s attitude, how she bores us to tears with her Patrie
Française, morning, noon and night.”
“Yes, but there’s not only his mother to be thought of, you can’t
humbug us like that. There’s a damsel, too, a fly-by-night of the
worst type; she has far more influence over him than his mother, and
she happens to be a compatriot of Master Dreyfus. She has passed
on her state of mind to Robert.”
“You may not have heard, Duke, that there is a new word to
describe that sort of mind,” said the librarian, who was Secretary to
the Antirevisionist Committee. “They say ‘mentality’. It means exactly
the same thing, but it has this advantage that nobody knows what
you’re talking about. It is the very latest expression just now, the ‘last
word’ as people say.” Meanwhile, having heard Bloch’s name, he
was watching him question M. de Norpois with misgivings which
aroused others as strong though of a different order in the Marquise.
Trembling before the librarian, and always acting the anti-Dreyfusard
in his presence, she dreaded what he would say were he to find out
that she had asked to her house a Jew more or less affiliated to the
“Syndicate”.
“Indeed,” said the Duke, “‘mentality’, you say; I must make a note
of that; I shall use it some day.” This was no figure of speech, the
Duke having a little pocket-book filled with such “references” which
he used to consult before dinner-parties. “I like ‘mentality’. There are
a lot of new words like that which people suddenly start using, but
they never last. I read somewhere the other day that some writer
was ‘talentuous’. You may perhaps know what it means; I don’t. And
since then, I’ve never come across the word again.”
“But ‘mentality’ is more widely used than ‘talentuous’,” the historian
of the Fronde made his way into the conversation. “I am on a
Committee at the Ministry of Education at which I have heard it used
several times, as well as at my Club, the Volney, and indeed at
dinner at M. Emile Ollivier’s.”
“I, who have not the honour to belong to the Ministry of Education,”
replied the Duke with a feigned humility but with a vanity so intense
that his lips could not refrain from curving in a smile, nor his eyes
from casting round his audience a glance sparkling with joy, the
ironical scorn in which made the poor historian blush, “I who have
not the honour to belong to the Ministry of Education,” he repeated,
relishing the sound of his words, “nor to the Volney Club (my only
clubs are the Union and the Jockey—you aren’t in the Jockey, I
think, sir?” he asked the historian, who, blushing a still deeper red,
scenting an insult and failing to understand it, began to tremble in
every limb.) “I, who am not even invited to dine with M. Emile Ollivier,
I must confess that I had never heard ‘mentality’. I’m sure you’re in
the same boat, Argencourt.
“You know,” he went on, “why they can’t produce the proofs of
Dreyfus’s guilt. Apparently it’s because the War Minister’s wife was
his mistress, that’s what people are saying.”
“Ah! I thought it was the Prime Minister’s wife,” said M.
d’Argencourt.
“I think you’re all equally tiresome about this wretched case,” said
the Duchesse de Guermantes, who, in the social sphere, was always
anxious to shew that she did not allow herself to be led by anyone.
“It can’t make any difference to me, so far as the Jews are
concerned, for the simple reason that I don’t know any of them, and I
intend to remain in that state of blissful ignorance. But on the other
hand I do think it perfectly intolerable that just because they’re
supposed to hold ‘sound’ views and don’t deal with Jewish
tradesmen, or have ‘Down with the Jews’ printed on their sunshades,
we should have a swarm of Durands and Dubois and so forth,
women we should never have known but for this business, forced
down our throats by Marie-Aynard or Victurnienne. I went to see
Marie-Aynard a couple of days ago. It used to be so nice there.
Nowadays one finds all the people one has spent one’s life trying to
avoid, on the pretext that they’re against Dreyfus, and others of
whom you have no idea who they can be.”
“No; it was the War Minister’s wife; at least, that’s the bedside
rumour,” went on the Duke, who liked to flavour his conversation with
certain expressions which he imagined to be of the old school.
“Personally, of course, as everyone knows, I take just the opposite
view to my cousin Gilbert. I am not feudal like him, I would go about
with a negro if he was a friend of mine, and I shouldn’t care two
straws what anybody thought; still after all you will agree with me
that when one goes by the name of Saint-Loup one doesn’t amuse
oneself by running clean against the rails of public opinion, which
has more sense than Voltaire or even my nephew. Nor does one go
in for what I may be allowed to call these acrobatics of conscience a
week before one comes up for a club. It is a bit stiff, really! No, it is
probably that little wench of his that has put him on his high horse. I
expect she told him that he would be classed among the
‘intellectuals’. The intellectuals, they’re the very cream of those
gentry. It’s given rise, by the way, to a rather amusing pun, though a
very naughty one.”
And the Duke murmured, lowering his voice, for his wife’s and M.
d’Argencourt’s benefit, “Mater Semita,” which had already made its
way into the Jockey Club, for, of all the flying seeds in the world, that
to which are attached the most solid wings, enabling it to be
disseminated at the greatest distance from its parent branch, is still a
joke.
“We might ask this gentleman, who has a nerudite air, to explain it
to us,” he went on, indicating the historian. “But it is better not to
repeat it, especially as there’s not a vestige of truth in the
suggestion. I am not so ambitious as my cousin Mirepoix, who
claims that she can trace the descent of her family before Christ to
the Tribe of Levi, and I will undertake to prove that there has never
been a drop of Jewish blood in our family. Still there is no good in our
shutting our eyes to the fact, you may be sure that my dear
nephew’s highly original views are liable to make a considerable stir
at Landerneau. Especially as Fezensac is ill just now, and Duras will
be running the election; you know how he likes to make nuisances,”
concluded the Duke, who had never succeeded in learning the exact
meaning of certain phrases, and supposed “making nuisances” to
mean “making difficulties”.
Bloch tried to pin M. de Norpois down on Colonel Picquart.
“There can be no two opinions;” replied M. de Norpois, “his
evidence had to be taken. I am well aware that, by maintaining this
attitude, I have drawn screams of protest from more than one of my
colleagues, but to my mind the Government were bound to let the
Colonel speak. One can’t dance lightly out of a blind alley like that, or
if one does there’s always the risk of falling into a ditch. As for the
officer himself, his statement gave one, at the first hearing, a most
excellent impression. When one saw him, looking so well in that
smart Chasseur uniform, come into court and relate in a perfectly
simple and frank tone what he had seen and what he had deduced,
and say: ‘On my honor as a soldier’” (here M. de Norpois’s voice
shook with a faint patriotic throb) “‘such is my conviction,’ it is
impossible to deny that the impression he made was profound.”
“There; he is a Dreyfusard, there’s not the least doubt of it,”
thought Bloch.
“But where he entirely forfeited all the sympathy that he had
managed to attract was when he was confronted with the registrar,
Gribelin. When one heard that old public servant, a man who had
only one answer to make,” (here M. de Norpois began to accentuate
his words with the energy of his sincere convictions) “when one
listened to him, when one saw him look his superior officer in the
face, not afraid to hold his head up to him, and say to him in a tone
that admitted of no response: ‘Colonel, sir, you know very well that I
have never told a lie, you know that at this moment, as always, I am
speaking the truth,’ the wind changed; M. Picquart might move
heaven and earth at the subsequent hearings; he made a complete
fiasco.”
“No; evidently he’s an anti-Dreyfusard; it’s quite obvious,” said
Bloch to himself. “But if he considers Picquart a traitor and a liar, how
can he take his revelations seriously, and quote them as if he found
them charming and believed them to be sincere. And if, on the other
hand, he sees in him an honest man easing his conscience, how can
he suppose him to have been lying when he was confronted with
Gribelin?”
“In any case, if this man Dreyfus is innocent,” the Duchess broke
in, “he hasn’t done much to prove it. What idiotic, raving letters he
writes from that island. I don’t know whether M. Esterhazy is any
better, but he does shew some skill in his choice of words, a different
tone altogether. That can’t be very pleasant for the supporters of M.
Dreyfus. What a pity for them there’s no way of exchanging
innocents.” Everybody laughed. “You heard what Oriane said?” the
Duc de Guermantes inquired eagerly of Mme. de Villeparisis. “Yes; I
think it most amusing.” This was not enough for the Duke. “Well, I
don’t know, I can’t say that I thought it amusing; or rather it doesn’t
make the slightest difference to me whether a thing is amusing or
not. I don’t care about wit.” M. d’Argencourt protested. “It is probably
because I’ve been a Member of Parliament, where I have listened to
brilliant speeches that meant absolutely nothing. I learned there to
value, more than anything, logic. That’s probably why they didn’t
elect me again. Amusing things leave me cold.” “Basin, don’t play
the heavy father like that, my child, you know quite well that no one
admires wit more than you do.” “Please let me finish. It is just
because I am unmoved by a certain type of humour, that I am often
struck by my wife’s wit. For you will find it based, as a rule, upon
sound observation. She reasons like a man; she states her case like
a writer.”
Possibly the explanation of M. de Norpois’s speaking in this way to
Bloch, as though they had been in agreement, may have lain in the
fact that he himself was so keen an anti-Dreyfusard that, finding the
Government not anti-Dreyfusard enough, he was its enemy just as
much as the Dreyfusards. Perhaps because the object to which he
devoted himself in politics was something more profound, situated
on another plane, from which Dreyfusism appeared as an
unimportant modality which did not deserve the attention of a patriot
interested in large questions of foreign policy. Perhaps, rather,
because the maxims of his political wisdom being applicable only to
questions of form, of procedure, of expediency, they were as
powerless to solve questions of fact as in philosophy pure logic is
powerless to tackle the problems of existence; or else because that
very wisdom made him see danger in handling such subjects and so,
in his caution, he preferred to speak only of minor incidents. But
where Bloch made a mistake was in thinking that M. de Norpois,
even had he been less cautious by nature and of a less exclusively
formal cast of mind, could (supposing he would) have told him the
truth as to the part played by Henry, Picquart or du Paty de Clam, or
as to any of the different aspects of the case. The truth, indeed, as to
all these matters Bloch could not doubt that M. de Norpois knew.
How could he fail to know it seeing that he was a friend of all the
Ministers? Naturally, Bloch thought that the truth in politics could be
approximately reconstructed by the most luminous minds, but he
imagined, like the man in the street, that it resided permanently,
beyond the reach of argument and in a material form, in the secret
files of the President of the Republic and the Prime Minister, who
imparted it to their Cabinet. Now, even when a political truth does
take the form of written documents, it is seldom that these have any
more value than a radiographic plate on which the layman imagines
that the patient’s disease is inscribed in so many words, when, as a
matter of fact, the plate furnishes simply one piece of material for
study, to be combined with a number of others, which the doctor’s
reasoning powers will take into consideration as a whole and upon
them found his diagnosis. So, too, the truth in politics, when one
goes to well-informed men and imagines that one is about to grasp
it, eludes one. Indeed, later on (to confine ourselves to the Dreyfus
case), when so startling an event occurred as Henry’s confession,
followed by his suicide, this fact was at once interpreted in opposite
ways by the Dreyfusard Ministers, and by Cavaignac and Cuignet
who had themselves made the discovery of the forgery and
conducted the examination; still more so among the Dreyfusard
Ministers themselves, men of the same shade of Dreyfusism, judging
not only from the same documents but in the same spirit, the part
played by Henry was explained in two entirely different ways, one set
seeing in him an accomplice of Esterhazy, the others assigning that
part to du Paty de Clam, thus rallying in support of a theory of their
opponent Cuignet and in complete opposition to their supporter
Reinach. All that Bloch could elicit from M. de Norpois was that if it
were true that the Chief of Staff, M. de Boisdeffre, had had a secret
communication sent to M. Rochefort, it was evident that a singularly
regrettable irregularity had occurred.
“You may be quite sure that the War Minister must (in petto at any
rate) be consigning his Chief of Staff to the infernal powers. An
official disclaimer would not have been (to my mind) a work of
supererogation. But the War Minister expresses himself very bluntly
on the matter inter pocula. There are certain subjects, moreover,
about which it is highly imprudent to create an agitation over which
one cannot retain control afterwards.”
“But those documents are obviously forged,” put in Bloch.
M. de Norpois made no reply to this, but announced that he did
not approve of the manifestations that were being made by Prince
Henri d’Orléans:
“Besides, they can only ruffle the calm of the pretorium, and
encourage agitations which, looked at from either point of view,
would be deplorable. Certainly we must put a stop to the anti-
militarist conspiracy, but we cannot possibly tolerate, either, a brawl
encouraged by those elements on the Right who instead of serving
the patriotic ideal themselves are hoping to make it serve them.
Heaven be praised, France is not a South American Republic, and
the need has not yet been felt here for a military pronunciamento.”
Bloch could not get him to speak on the question of Dreyfus’s guilt,
nor would he utter any forecast as to the judgment in the civil trial
then proceeding. On the other hand, M. de Norpois seemed only too
ready to indicate the consequences of this judgment.
“If it is a conviction,” he said, “it will probably be quashed, for it is
seldom that, in a case where there has been such a number of
witnesses, there is not some flaw in the procedure which counsel
can raise on appeal. To return to Prince Henri’s outburst, I greatly
doubt whether it has met with his father’s approval.”
“You think Chartres is for Dreyfus?” asked the Duchess with a
smile, her eyes rounded, her cheeks bright, her nose buried in her
plate, her whole manner deliciously scandalised.
“Not at all; I meant only that there runs through the whole family,
on that side, a political sense which we have seen, in the admirable
Princesse Clémentine, carried to its highest power, and which her
son, Prince Ferdinand, has kept as a priceless inheritance. You
would never have found the Prince of Bulgaria clasping Major
Esterhazy to his bosom.”
“He would have preferred a private soldier,” murmured Mme. de
Guermantes, who often met the Bulgarian monarch at dinner at the
Prince de Joinville’s, and had said to him once, when he asked if she
was not envious: “Yes, Sir, of your bracelets.”
“You aren’t going to Mme. de Sagan’s ball this evening?” M. de
Norpois asked Mme. de Villeparisis, to cut short his conversation
with Bloch. My friend had not failed to interest the Ambassador, who
told us afterwards, not without a quaint simplicity, thinking no doubt
of the traces that survived in Bloch’s speech of the neo-Homeric
manner which he had on the whole outgrown: “He is rather amusing,
with that way of speaking, a trifle old fashioned, a trifle solemn. You
expect him to come out with ‘The Learned Sisters’, like Lamartine or
Jean-Baptiste Rousseau. It has become quite uncommon in the
youth of the present day, as it was indeed in the generation before
them. We ourselves were inclined to be romantic.” But however
exceptional his companion may have seemed to him, M. de Norpois
decided that the conversation had lasted long enough.
“No, sir, I don’t go to balls any more,” she replied with a charming
grandmotherly smile. “You’re going, all of you, I suppose? You’re the
right age for that sort of thing,” she added, embracing in a
comprehensive glance M. de Châtellerault, his friend and Bloch.
“Still, I was asked,” she went on, pretending, just for fun, to be
flattered by the distinction. “In fact, they came specially to ask me.”
(“They” being the Princesse de Sagan.)
“I haven’t had a card,” said Bloch, thinking that Mme. de
Villeparisis would at once offer to procure him one, and that Mme. de
Sagan would be glad to see at her ball the friend of a woman whom
she had called in person to invite.
The Marquise made no reply, and Bloch did not press the point, for
he had another, more serious matter to discuss with her, and, with
that in view, had already asked her whether he might call again in a
couple of days. Having heard the two young men say that they had
both just resigned from the Rue Royale Club, which was letting in
every Tom, Dick and Harry, he wished to ask Mme. de Villeparisis to
arrange for his election there.
“Aren’t they rather bad form, rather stuck-up snobs, these
Sagans?” he inquired in a tone of sarcasm.
“Not at all, they’re the best we can do for you in that line,” M.
d’Argencourt, who adopted all the catch-words of Parisian society,
assured him.
“Then,” said Bloch, still half in irony, “I suppose it’s one of the
solemnities, the great social fixtures of the season.”
Mme. de Villeparisis turned merrily to Mme. de Guermantes.
“Tell us, is it a great social solemnity, Mme. de Sagan’s ball?”
“It’s no good asking me,” answered the Duchess, “I have never yet
succeeded in finding out what a social solemnity is. Besides, society
isn’t my strong point.”
“Indeed; I thought it was just the other way,” said Bloch, who
supposed Mme. de Guermantes to be speaking seriously.
He continued, to the desperation of M. de Norpois, to ply him with
questions about the Dreyfus case. The Ambassador declared that,
looking at it from outside, he got the impression from du Paty de
Clam of a somewhat cloudy brain, which had perhaps not been very
happily chosen to conduct that delicate operation, which required so
much coolness and discernment, a judicial inquiry.
“I know that the Socialist Party are crying aloud for his head on a
charger, as well as for the immediate release of the prisoner from the
Devil’s Isle. But I think that we are not yet reduced to the necessity of
passing the Caudine Forks of MM. Gérault-Richard and Company.
So far the whole case has been an utter mystery, I don’t say that on
one side just as much as on the other there has not been some
pretty dirty work to be hushed up. That certain of your client’s more
or less disinterested protectors may have the best intentions I will not
attempt to deny, but you know that heaven is paved with such
things,” he added, with a look of great subtlety. “It is essential that
the Government should give the impression that they are not in the
hands of the factions of the Left, and that they are not going to
surrender themselves, bound hand and foot, at the demand of some
pretorian guard or other, which, believe me, is not the same thing as
the Army. It stands to reason that, should any fresh evidence come
to light, a new trial would be ordered. And what follows from that?
Obviously, that to demand a new trial is to force an open door. When
the day comes, the Government will speak with no uncertain voice or
will let fall into abeyance what is their essential prerogative. Cock
and bull stories will no longer be enough. We must appoint judges to
try Dreyfus. And that will be an easy matter because, although we
have acquired the habit, in our sweet France, where we love to
belittle ourselves, of thinking or letting it be thought that, in order to
hear the words Truth and Justice, it is necessary to cross the
Channel, which is very often only a roundabout way of reaching the
Spree, there are judges to be found outside Berlin. But once the
machinery of Government has been set in motion, will you have ears
for the voice of authority? When it bids you perform your duty as a
citizen will you have ears for its voice, will you take your stand in the
ranks of law and order? When its patriotic appeal sounds, will you
have the wisdom not to turn a deaf ear but to answer: ‘Present!’?”
M. de Norpois put these questions to Bloch with a vehemence
which, while it alarmed my friend, flattered him also; for the
Ambassador spoke to him with the air of one addressing a whole
party, questioned him as though he had been in the confidence of
that party and might be held responsible for the decisions which it
would adopt. “Should you fail to disarm,” M. de Norpois went on,
without waiting for Bloch’s collective answer, “should you, before
even the ink had dried on the decree ordering the fresh trial of the
case, obeying it matters not what insidious word of command, fail, I
say, to disarm, and band yourselves, rather, in a sterile opposition
which seems to some minds the ultima ratio of policy, should you
retire to your tents and burn your boats, you would be doing so to
your own damnation. Are you the prisoners of those who foment
disorder? Have you given them pledges?” Bloch was in doubt how to
answer. M. de Norpois gave him no time. “If the negative be true, as
I should like to think, and if you have a little of what seems to me to
be lamentably lacking in certain of your leaders and your friends,
namely political sense, then, on the day when the Criminal Court
assembles, if you do not allow yourselves to be dragooned by the
fishers in troubled waters, you will have won your battle. I do not
guarantee that the whole of the General Staff is going to get away
unscathed, but it will be so much to the good if some of them at least
can save their faces without setting the heather on fire.
“It stands to reason, moreover, that it is with the Government that it
rests to pronounce judgment, and to close the list—already too long
—of unpunished crimes, not certainly at the bidding of Socialist
agitators, nor yet of any obscure military mouthpiece,” he added,
looking Bloch boldly in the face, perhaps with the instinct that leads
all Conservatives to establish support for themselves in the enemy’s
camp. “Government action is not to be dictated by the highest bidder,
from wherever the bid may come. The Government are not, thank
heaven, under the orders of Colonel Driant, nor, at the other end of
the scale, under M. Clemenceau’s. We must curb the professional
agitators and prevent them from raising their heads again. France,
the vast majority here in France, desires only to be allowed to work
in orderly conditions. As to that, there can be no question whatever.
But we must not be afraid to enlighten public opinion; and if a few
sheep, of the kind our friend Rabelais knew so well, should dash
headlong into the water, it would be as well to point out to them that
the water in question was troubled, that it had been troubled

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Foundations of Finance (Pearson

eTextbook 978-0133507676 Fundamentals of Corporate

eTextbook 978-0133507690 Principles of Managerial

Foundations of Finance John D. Martin

eTextbook 978-0132743464 Multinational Business Finance

Principles of Corporate Finance (Mcgraw-hill/Irwin

Foundations of Finance, Global Edition 9th Edition,

Foundations of Airport Economics and Finance Hans-

Fundamentals of Investing (Pearson Series in Finance) –

PART 1 The Scope and Environment

PART 2 The Valuation of Financial Assets 152

PART 3 Investment in Long-Term Assets 326

PART 4 Capital Structure and Dividend Policy 406

PART 5 Working-Capital Management and International

PART 1 The Scope and Environment

1 An Introduction to the Foundations of Financial

Chapter Summaries 18 • Review Questions 20 • Mini Case 21

2 The Financial Markets and Interest Rates 22

Interest Rate Determinants in a Nutshell 38

Chapter Summaries 47 • Review Questions 50 • Study Problems 50 • Mini Case 53

3 Understanding Financial Statements and Cash

Chapter Summaries 85 • Review Questions 88 • Study Problems 89 • Mini Case 97

Appendix 3A: Free Cash Flows 100

Study Problems 104

4 Evaluating a Firm’s Financial Performance 106

The Limitations of Financial Ratio Analysis 138

Chapter Summaries 139 • Review Questions 142 • Study Problems 142

PART 2 The Valuation of Financial Assets 152

5 The Time Value of Money 152

Chapter Summaries 184 • Review Questions 187 • Study Problems 187

6 The Meaning and Measurement of Risk

Chapter Summaries 225 • Review Questions 229 • Study Problems 229

7 The Valuation and Characteristics

Terminology and Characteristics of Bonds 239

Chapter Summaries 260 • Review Questions 263 • Study Problems 264

8 The Valuation and Characteristics

Chapter Summaries 287 • Review Questions 290 • Study Problems 290

9 The Cost of Capital 294

Calculating Divisional Costs of Capital 311

Chapter Summaries 317 • Review Questions 319 • Study Problems 320

PART 3 Investment in Long-Term Assets 326

10 Capital-Budgeting Techniques and Practice 326

Chapter Summaries 356 • Review Questions 359 • Study Problems 359

11 Cash Flows and Other Topics in Capital

Risk and the Investment Decision 385

Chapter Summaries 394 • Review Questions 396 • Study Problems 396

Appendix 11A: The Modified Accelerated Cost

Study Problems 405

PART 4 Capital Structure and Dividend Policy 406

12 Determining the Financing Mix 406

Chapter Summaries 436 • Review Questions 439 • Study Problems 439

13 Dividend Policy and Internal Financing 444

The Dividend Decision in Practice 452

Chapter Summaries 459 • Review Questions 461 • Study Problems 462

PART 5 Working-Capital Management and International

14 Short-Term Financial Planning 466

Chapter Summaries 477 • Review Questions 478 • Study Problems 479

15 Working-Capital Management 486

Secured Sources: Accounts-Receivable Loans 503

Chapter Summaries 506 • Review Questions 509 • Study Problems 510

16 International Business Finance 514

Chapter Summaries 530 • Review Questions 532 • Study Problems 533

Web 17 Cash, Receivables, and Inventory Management