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PARRINO | KIDWELL | AU YONG | DEMPSEY | MORKEL-KINGSBURY | EKANAYAKE | JAMES | MURRAY

BUSINESS FINANCE FIRST EDITION

 The importance of capital budgeting 257
The capital budgeting process 257
Sources of information 258
Classification of investment projects 259
Basic capital budgeting terms 259
8.2 Net present value 260
Valuation of real assets 260
NPV — the basic concept 261
NPV and value creation 261
Framework for calculating NPV 262
Net present value technique 264
Concluding comments on NPV 268
8.3 The payback period 269
Calculating the payback period 269
How the payback period performs 271
Discounted payback period 272
Evaluating the payback rule 273
8.4 The accounting rate of return 274
8.5 Internal rate of return 274
Calculating the IRR 275
When the IRR and NPV methods agree —
independent projects and conventional cash
flows 278
When the IRR and NPV methods disagree —
mutually exclusive projects and unconventional
cash flows 279
Modified internal rate of return (MIRR) 284
IRR versus NPV: a final comment 285
8.6 Capital budgeting in practice 286
Practitioners’ methods of choice 286
Ongoing and postaudit reviews 287
Summary of learning objectives 288
Key terms 289
Summary of key equations 289
Self-study problems 290
Critical thinking questions 290
Questions and problems 291
Appendix: An example using a financial calculator for
capital budgeting calculations 297
Endnotes 299
Acknowledgements 300
CHAPTER 9
Cash flows and capital
budgeting 301
Chapter preview 303
9.1 Calculating project cash flows 303
Cash flow versus accounting
earnings 304
CONTENTS vi
Incremental after-tax free cash flows 304
The FCF calculation 305
Cash flows from operations 306
Cash flows associated with investments 307
The FCF calculation: an example 307
9.2 Estimating cash flows in practice 312
Five general rules for incremental after-tax free
cash flow calculations 312
Nominal versus real cash flows 315
Tax rates and depreciation 318
Calculating the terminal-year FCF 319
Expected cash flows 321
9.3 Projects with different lives 322
9.4 When to harvest an asset 326
When to replace an existing asset 327
The cost of using an existing asset 328
Summary of learning objectives 330
Key terms 331
Summary of key equations 331
Self-study problems 332
Critical thinking questions 332
Questions and problems 333
Endnotes 337
Acknowledgements 337
CHAPTER 10
Evaluating project
economics and capital
rationing 338
Chapter preview 339
10.1 Variable costs, fixed costs and project
risk 340
Cost structure and sensitivity of EBITDA to
revenue changes 341
Cost structure and sensitivity of EBIT to revenue
changes 344
10.2 Calculating operating leverage 347
Degree of pre-tax cash flow operating
leverage 347
Degree of accounting operating leverage 348
10.3 Break-even analysis 350
Pre-tax operating cash flow break-even 350
Accounting break-even 352
10.4 Risk analysis 355
Sensitivity analysis 356
Scenario analysis 356
Simulation analysis 357
Decision tree analysis 358
10.5 Investment decisions with capital CHAPTER 12
rationing 359
Capital rationing in a single period 359 Working capital
Capital rationing across multiple periods 362 management 408
Chapter preview 410
Summary of learning objectives 363 12.1 Working capital basics 410
Key terms 364 Working capital terms and concepts 410
Summary of key equations 364
Working capital accounts and trade-offs 412
Self-study problems 365
12.2 The operating and cash conversion
Critical thinking questions 365
cycles 413
Questions and problems 366
Endnotes 369 Operating cycle 414
Acknowledgements 369 Cash conversion cycle 416
12.3 Working capital management strategies 418
CHAPTER 11 Flexible current asset management strategy 419
Restrictive current asset management
The cost of capital 370 strategy 419
Chapter preview 372 The working capital trade-off 419
11.1 The company’s overall cost of capital 372 12.4 Accounts receivable 420
The finance balance sheet 373 Terms of sale 420
How companies estimate their cost of capital 375 Ageing accounts receivable 422
11.2 The cost of debt 377 12.5 Inventory management 423
Key concepts for estimating the cost of debt 377 Economic order quantity 423
Estimating the current cost of a bond or an Just-in-time inventory management 425
outstanding loan 378 12.6 Cash management and budgeting 425
Tax and the cost of debt 380 Reasons for holding cash 425
Estimating the cost of debt for a company 380 Cash collection 426
11.3 The cost of equity 383 12.7 Financing working capital 427
Ordinary shares 383 Strategies for financing working capital 427
Preference shares 389 Financing working capital in practice 429
11.4 Using the WACC in practice 391 Sources of short-term financing 429
Calculating WACC: an example 392
Limitations of WACC as a discount rate for Summary of learning objectives 433
evaluating projects 394 Key terms 434
Alternatives to using WACC for evaluating Summary of key equations 435
projects 397 Self-study problems 435
Consistency of the WACC and Dividend Discount Critical thinking questions 435
Models 399 Questions and problems 436
Endnotes 440
Summary of learning objectives 400 Acknowledgements 440
Key terms 400
Summary of key equations 401 CHAPTER 13
Self-study problems 401
Critical thinking questions 401 How companies raise
Questions and problems 402 capital 441
Sample test problems 405
Chapter preview 442
Endnotes 405
Acknowledgements 406 13.1 Bootstrapping 443
How new businesses get started 443
PART 4 Initial funding of the company 443
13.2 Venture capital 444
Working capital management The venture capital industry 444
and financing decisions 407 Why venture capital funding is different 444

vii CONTENTS
 The venture capital funding cycle 445
The cost of venture capital funding 448
13.3 Initial public offering 449
Advantages and disadvantages of going
public 449
Investment banking services 450
Origination 451
Underwriting 451
The proceeds 453
13.4 IPO pricing and cost 454
The underpricing debate 454
IPOs are consistently underpriced 455
The cost of an IPO 456
13.5 Open offers by a public company 457
The cost of an open public offer 458
13.6 Private markets and bank loans 458
Private versus public markets 458
Private placements 459
Private equity companies 459
13.7 Commercial bank lending 460
Business overdraft 461
Bank term loans 461
The loan pricing model 461
Concluding comments on funding the
company 463
Summary of learning objectives 464
Key terms 465
Summary of key equation 465
Self-study problems 465
Critical thinking questions 466
Questions and problems 466
Endnotes 468
Acknowledgements 468
CHAPTER 14
Capital structure policy 469
Chapter preview 471
14.1 Capital structure and company value 471
The optimal capital structure 471
The Modigliani and Miller propositions 472
14.2 The benefits and costs of using debt 481
The benefits of debt 481
The costs of debt 488
14.3 Two theories of capital structure 494
The trade-off theory 494
The pecking order theory 494
The empirical evidence 495
CONTENTS viii
14.4 Practical considerations in choosing a
capital structure 496
Summary of learning objectives 498
Key terms 499
Summary of key equations 499
Self-study problems 500
Critical thinking questions 500
Questions and problems 501
Endnotes 504
Acknowledgements 504
CHAPTER 15
Dividends and dividend
policy 505
Chapter preview 506
15.1 Dividends 507
Types of dividends 507
Dividends and taxation 508
The dividend payment process 509
15.2 Share buy-backs 512
How share buy-backs differ from dividends 512
How a share buy-back happens 513
15.3 Dividend policy and company value 514
Benefits and costs of dividends 515
Share price reactions to dividend
announcements 517
Dividends versus share buy-backs 518
15.4 Bonus share issues and share splits 519
Bonus share issues 519
Share splits 520
Reasons for bonus share issues and splits 520
15.5 Setting a dividend policy 521
What managers tell us 521
Practical considerations in setting a dividend
policy 521
Summary of learning objectives 523
Key terms 524
Self-study problems 524
Critical thinking questions 525
Questions and problems 525
Endnotes 527
Acknowledgements 527
APPENDIX
Present value and future value
tables 528
ABOUT THE AUTHORS
Robert Parrino is the Lamar Savings Centennial Professor of Finance in the McCombs School of Busi-
ness, University of Texas at Austin. He is the Associate Editor of Journal of Corporate Finance and
Journal of Financial Research. He has experience in the application of corporate finance concepts in a
variety of business situations and researches on corporate governance, financial policies, restructuring,
mergers and acquisitions, and private equity markets.

David S. Kidwell is Professor of Finance and Dean Emeritus at the Curtis L. Carlson School of Man-
agement, University of Minnesota. He has over 30 years’ experience in financial education, as a teacher,
researcher and administrator. He has published in leading journals such as Journal of Finance, Journal
of Financial Economics, Journal of Financial and Quantitative Analysis, Financial Management and
Journal of Money, Credit and Banking.

Hue Hwa Au Yong is a Senior Lecturer in the Department of Accounting and Finance at Monash Uni-
versity. Prior to this, she completed her PhD in the area of risk management at Monash University.
Her research has been published in several international peer reviewed journals, including Journal
of International Financial Markets, Institutions and Money; Australian Journal of Management; and
International Review of Financial Analysis. She specialises in teaching corporate finance. In 2009, she
was awarded the Faculty of Business and Economics Dean’s Commendation for Outstanding Teaching.

Michael Dempsey is a Professor of Finance in the Department of Economics, Finance and Marketing at
RMIT University. Prior to this, he was with Monash University and Griffith University, having previ-
ously been at Leeds University, United Kingdom. He also has many years’ experience working for the
petroleum exploration industry in the Middle East, Aberdeen and London. His PhD was obtained in
Astrophysics. His teaching responsibilities have been in corporate and investment finance, international
finance, derivatives and financial engineering. He is an active researcher and research supervisor in the
area of financial markets and the formation of asset prices, where he has continued to publish as well as
referee major journal articles.

Samson Ekanayake is a Senior Lecturer in finance at Deakin University. He has been teaching busi-
ness and corporate finance at Deakin since 1992 and also served as the Discipline Leader for Finance
until July 2010. Samson has won several awards for teaching excellence in business finance and was
nominated for Faculty Awards for innovative teaching in 2010. His research interests include corporate
finance, management control and enterprise risk management. Before joining Deakin University, he held
senior managerial positions in accounting and finance in several reputed companies. To name a few,
he was the Finance Manager of Mitsubishi Olayan Machinery Industries, Corporate Treasurer of The
Finance Company, and Economist of Fiji Sugar Corporation. Samson is a Chartered Accountant and a
Certified Practising Accountant. He completed his postgraduate studies at the University of Lancaster in
England.

Jennifer James was formerly a Lecturer in the School of Business and Law at Central Queensland
University. She has over 12 years teaching experience and specialises in teaching corporate finance and
auditing and professional practice. In 2008, she was awarded the Faculty of Business and Informatics
Award for Teaching Excellence and Central Queensland University’s Innovative Teacher of the Year
Award. Jenny was awarded an ALTC Citation for Outstanding Contributions to Student Learning in
2009. Her research interests focus on improving her teaching strategies to maximise student learning.
In 2009, she was awarded an Outstanding Paper Award at the World Conference on Educational Media
and Technology in Honolulu and the Edith Cowan Authentic Learning Award at the Higher Education
Research and Development Society of Australasia Conference in Darwin.
Nigel Morkel-Kingsbury is a Lecturer in the Department of Banking and Finance at Monash Univer-
sity. He is an experienced educator at both graduate and undergraduate levels, specialising in teaching
corporate finance and international study programs. His research interests and publications include the
following areas: central bank transparency and interest rates (the topic of his doctoral thesis), monetary
policy, corporate finance and initial public offerings.
James Murray previously taught at Monash University, and has also tutored at Swinburne University
of Technology and Lincoln University. He completed his PhD in the area of dividend policy at Monash
University. His research interests primarily relate to the role of the legal and tax environment in cor-
porate finance.

ABOUT THE AUTHORS x

PREFACE
Business finance, 1st edition, has been developed for use in an introductory course in finance.

Balance between conceptual understanding and

computational skills
Business finance reflects the reality that finance, as an intellectual discipline, continues to be challenged
by the experiences and events of market activity. Since the global financial crisis, managers have faced
uncertain times. Thus, although the teaching of finance may have remained robust as a framework of
conceptual thought, it is imperative that students come to realise that ‘finance is not physics’, by which
we mean that even a concept as foundational to financial management as the capital asset pricing model
(CAPM) should not be interpreted as a literal truth. This leads to a consideration of managing risk and
risk management approaches as having behavioural aspects that are the outcomes of a manager’s or the
firm’s accumulated experience. They cannot always be reduced to the simple directives of a quantitative
algorithm.
Our primary objective in writing this text was to provide students and lecturers with a book that
strikes the best possible balance between helping students develop an intuitive understanding of key
financial concepts and providing them with problem-solving and decision-making skills. In our experi-
ence, teaching students at all levels, we have found that students who understand the intuition under-
lying the basic concepts of finance are better able to develop the critical judgement necessary to apply
financial tools to a broad range of real-world situations. An introductory corporate finance course should
provide students with a strong understanding of both the concepts and tools that will help them in their
subsequent business studies and personal and professional lives.
Market research supports our view. Academics who teach the introductory corporate finance course
to undergraduates express a desire for a resource that bridges the gap between conceptually focused
and computationally focused. This text is designed to bridge this gap. Specifically, the text develops the
fundamental concepts underlying corporate finance in an intuitive manner while maintaining a strong
emphasis on developing computational skills. It also takes the students one step further by emphasising
the use of intuition and analytical skills in decision making.
Our ultimate goal has been to write a resource and develop associated learning tools that help our
colleagues succeed in the classroom — materials that are genuinely helpful in the learning process. Our
resource offers a level of rigour that is appropriate for finance majors and yet presents the content in a
manner that both finance and non-finance students find accessible and want to read. Writing a resource
that is both rigorous and accessible has therefore been one of our key objectives. We have also tried to
provide solutions to many of the challenges facing academics in the current environment, academics
who are asked to teach ever-increasing numbers of students with limited resources. Finance academics
need a resource and associated learning tools that help them effectively leverage their time. The organ-
isation of this resource and the supplementary materials provide such leverage to an extent not found
with other textbooks.

A focus on value creation

This resource is more than a collection of ideas, equations and chapters. It has an important integrating
theme — that of value creation. This theme, which is carried throughout the resource, provides a frame-
work that helps students understand the relations between the various concepts covered in the resource
and makes it easier for them to learn these concepts.
The concept of value creation is the most fundamental notion in corporate finance. It is in share-
holders’ best interests for value maximisation to be at the heart of the financial decisions made within
the company. Thus, it is critical that students be able to analyse and make business decisions with a
focus on value creation. The concept of value creation is introduced in the first chapter and is further
developed and applied throughout the remaining chapters.
The theme of value creation is operationalised through the net present value (NPV) concept. Once
students grasp the fundamental idea that financial decision makers should choose only courses of action
whose benefits exceed their costs, analysis and decision making, using NPV becomes common sense.
By helping students better understand the economic rationale for a decision from the outset, rather than
initially focusing on computational skills, our text helps students remain focused on the true purpose of
the calculations and the decision at hand.

Integrated approach: intuition, analysis and decision making

To support the focus on value creation, we have emphasised three approaches: (1) providing an intuitive
framework for understanding fundamental finance concepts, (2) teaching students how to analyse and
solve finance problems and (3) helping students develop the ability to use the results from their analyses
to make good financial decisions.
1. An intuitive approach. We believe that explaining finance concepts in an intuitive context helps
students develop a richer understanding of those concepts and gain better insights into how finance
problems can be approached. It is our experience that students who have a strong conceptual under-
standing of finance theory better understand how things really work and are better problem solvers
and decision makers than students who focus primarily on computational skills.
2. Analysis and problem solving. With a strong understanding of the basic principles of finance, stu-
dents are equipped to tackle a wide range of financial problems. In addition to the many numerical
examples that are solved in the text of each chapter, this book has more than 1000 end-of-chapter
homework and review problems that have been written with Bloom’s Taxonomy in mind. We strive to
help students acquire the ability to analyse and solve finance problems.
3. Decision making. In the end, we want to prepare students to make sound financial decisions. To help
students develop these skills, throughout the text we illustrate how the results from financial analyses
are used in decision making.
Robert Parrino
David S. Kidwell
Hue Hwa Au Yong
Michael Dempsey
Samson Ekanayake
Jennifer James
Nigel Morkel-Kingsbury
James Murray
May 2016

PREFACE xii
ORGANISATION
AND COVERAGE
In order to help students develop the skills necessary to tackle investment and financing decisions, we
have arranged the 15 chapters into major building blocks that collectively comprise the four parts of the
resource, as described below.

Introduction
Part 1, which consists of chapters 1 and 2, provides an introduction to corporate finance and the financial
environment. Chapter 1 describes the role of the financial manager, the types of fundamental decisions
that financial managers make, alternative forms of business organisation, the goal of the company,
agency problems and how they arise, and the importance of ethics in financial decision making. These
discussions set the stage and provide a framework that students can use to think about key concepts as
the course progresses. Chapter 2 explains the services financial institutions provide to new businesses,
how domestic and international financial markets work, how firms use financial markets, and how the
level of interest rates in the economy is determined.

Basic concepts and tools

Part 2 presents basic financial concepts and tools and illustrates their application. This part of the text,
which consists of chapters 3 to 7, introduces the time value of money and risk and return concepts and
extends them to cover the principles underlying the application of present value concepts to bond and
share valuation. These chapters provide students with basic financial intuition and computational tools that
will serve as the building blocks for analysing investment and financing decisions in subsequent chapters.

Analysis
Parts 3 and 4 of the text focus on investment and financing decisions. Part 3 covers capital budgeting.
Chapter 8 introduces the concept of net present value and illustrates its application. This discussion
provides a framework that will help students in the rest of part 3 as they learn the nuances of capital
budgeting analysis in realistic settings.
Chapters 9 and 10 follow with in-depth discussions of how cash flows are calculated and forecast. The
cash flow calculations are presented in chapter 9 using a valuation framework that will help students think
about valuation concepts in an intuitive way. Chapter 10 covers analytical tools — such as break-even, sensi-
tivity, scenario and simulation analysis — that will give students a better appreciation for how they can deal
with the uncertainties associated with cash flow forecasts. Capital rationing is also covered in chapter 10.
Chapter 11 explains how the discount rates used in capital budgeting are estimated. This chapter
uses an innovative concept — that of the finance balance sheet — to help students develop an intuitive
understanding of the relationships between the costs of the individual components of capital and the
company’s overall weighted average cost of capital. It also provides a detailed discussion of methods
used to estimate the costs of the individual components of capital that are used to finance a company’s
investments and how these estimates are used in capital budgeting.
Part 4 covers working capital management and financing decisions. It begins, in chapter 12, with
a discussion of how companies manage their working capital and the implications of working capital
management decisions for financing decisions and company value. This discussion is followed, in
chapters 13 and 14, with discussions of how companies raise capital to fund their real activities and
what factors affect how firms choose among the various sources of capital available to them. Chapter 15
rounds out the discussion of financing decisions with an introduction to dividends and dividend policy.
APPLICATIONS AT
A GLANCE
The real-world examples in Business finance, 1st edition, have been carefully chosen to include a bal-
ance of organisations operating in our region representing a diverse range of relevant product and service
industries.

1 The financial manager and the company

a2 Milk Company Reviews the reasons managers create company value and finance a company
either through debt or equity. Focuses on the value created by a2 Milk’s market
capitalisation.

2 The financial environment and the level of interest rates

The Reserve Bank Discusses how the Reserve Bank of Australia manages monetary policy and the
of Australia implications this has for economic activity.

3 The time value of money

Harvey Norman and Provides glimpses into the different financing options about which retail
The Good Guys consumers must make decisions every day, including the analysis of expected
cash flows.

4 Discounted cash flows and valuation

Superannuation in Australia Discusses the importance of planning for retirement, ensuring the compounding
of multiple cash flows.

5 Risk and return

Xero and Woolworths Technology companies are currently experiencing high growth, but this comes
with increased risk. The returns of Xero are compared against blue chip food
retailer, Woolworths.

6 Bond valuation and the structure of interest rates

The European Union The Greek sovereign debt crisis has highlighted the major risk faced by
debt crisis bondholders — the risk of default.

7 Share valuation
Rise and fall of share prices Investigates the ASX All Ordinaries Index and raises the question: how can one
tell if the market price of a share reflects its value?

8 The fundamentals of capital budgeting

BHP Billiton Reveals some of the capital budgeting decisions BHP Billiton has made in
recent years to maintain its competitive advantage.

9 Cash flows and capital budgeting

Justine’s Limited Capital budgeting decisions and cash flows are important for an expanding
business such as Justine’s Limited. These concepts would be employed as it
purchases new equipment.

10 Evaluating project economics and capital rationing

The mining industry Mining is an industry in which project analysis is crucial in evaluating the
appropriate level of capital investment.
11 The cost of capital
Q1 Tower, Gold Coast How does one estimate what it would cost to finance a project such as the Q1
Tower? This example initiates the discussion on how to take account of the cost
of capital in financing decisions.

12 Working capital management

Whitehaven Coal Limited In an environment of increasing expansion of its coal mines, Whitehaven Coal
Limited found it was important to effectively manage its working capital.

13 How companies raise capital

Amaysim Australian Limited Describes how amaysim raised capital through an initial public offering.

14 Capital structure policy

PKF — chartered accountants Discusses why it is vital that companies have the right capital structure mix for
and business advisers their business.

15 Dividends and dividend policy

BHP Billiton Examines the recent dividends paid out by BHP Billiton.

xv APPLICATIONS AT A GLANCE
HOW TO USE THIS
RESOURCE
Business finance, 1st edition, has been designed with you — the student — in mind. The design is our
attempt to provide you with a resource that both communicates the subject matter and will facilitate
learning. We have tried to accomplish these goals through the following elements.

Chapter scene setter

Each chapter begins with a vignette that describes a real company application. The vignettes illus-
trate concepts that will be presented in the chapter and are meant to heighten student interest, motivate
learning and demonstrate the real-life relevance of the material in the chapter.

chapter 12

Working capital
management
Le ar ni ng Ob je ct i v e s Learning objectives The opening
After studying this chapter, you should be able to:
12.1 define and calculate net working capital and discuss the importance of working capital management
vignette is accompanied by learning
12.2 define the operating and cash conversion cycles, explain their use, and calculate their values
12.3 discuss the relative advantages and disadvantages of pursuing (1) flexible and (2) restrictive current objectives that identify the most
asset management strategies
12.4 explain how accounts receivable are created and managed, and calculate the cost of trade credit
12.5 explain the trade-off between carrying costs and reorder costs, and calculate the economic order
important material for students to
quantity for inventory
12.6 define cash collection time and discuss how a company can minimise this time understand while reading the chapter. A
12.7 identify three current asset financing strategies and discuss the main sources of short-term financing.
summary of learning objectives appears
at the end of the chapter.

Key pOINt

high fixed costs mean larger fluctuations in cash flows and profits
The higher the proportion of fixed costs to variable costs in a project, the more pre-tax operating cash
flows (EBITDA) and accounting operating profits (EBIT) will vary as revenue varies. This is true because it
is more difficult to change fixed costs than to change variable costs when unit sales change. If unit sales
decline, EBITDA and EBIT will drop more in a business where fixed costs represent a larger proportion
of total costs. Conversely, if unit sales increase, EBITDA and EBIT will increase more in a business with
higher fixed costs.

demONstratION prOBLem 10.1

c12WorkingCapitalManagement
forecasting eBIt
problem
You have decided to start a business that pro-
vides in-home technical computer support to
408 15 December 2015 7:20 PM people in the suburb near your university. You
have seen national advertisements for a com-
pany that provides these services in other sub-
urbs. You would run this business out of your
room, and you know plenty of students who
have the necessary technical skills and would

Demonstration problem Along with a

welcome the opportunity to earn some pocket
money. To get up and running quickly, you
would have to invest in a computer system, an

generous number of in-text examples, most advertising campaign, three vehicles and tools.
You would also want to have enough cash to
keep the business going until it began to gen-

chapters include several demonstration erate positive cash flows. All of this would require about $100 000, which is about all that you think you
can borrow on your credit cards, against your car, and from friends and family.
You are now working on the financial forecasts for the business. You plan to charge $45 for house
problems. These demonstrations contain calls lasting up to 30 minutes and $25 for each additional 30 minutes. Since you expect that the typical
house call will require 60 minutes, you expect it to result in revenue of $70. You also estimate that

quantitative problems with step-by-step

monthly fixed operating costs (FC) which include an advertising contract with a local radio station and
a small salary for you, will total $3000. Unit VC, including the technicians’ pay, petrol and so forth, will
total $20 for the typical house call. Monthly depreciation and amortisation charges (D&A) will be $1000.

solutions to help students better understand

Finally, you expect that after 6 months the business will average 120 house calls per month. Given this
information, what do you expect the monthly EBIT to be in 6 months?
approach
how to apply their intuition and analytical Since EBIT = Revenue - VC - FC - D&A (see, for example, figure 10.5), you can forecast the expected
monthly EBIT in 6 months by using this equation and the values for Revenue, VC, FC and D&A that you

skills to solve important problems. By

expect in 6 months.
solution
The calculation is as follows:
including these exercises, we provide Revenue $70 per house call × 120 calls $8400

students with additional practice in the

- VC $20 per house call × 120 calls 2400
- FC 3000
- D&A 1000

application of the concepts, tools and EBIT $2000

methods that are discussed in the text. Chapter 10 Evaluating project economics and capital rationing 345

c10EvaluatingProjectEconomicsAndCapitalRationing 345 14 December 2015 6:19 PM

 Key pOINt

high fixed costs mean larger fluctuations in cash flows and profits
The higher the proportion of fixed costs to variable costs in a project, the more pre-tax operating cash
flows (EBITDA) and accounting operating profits (EBIT) will vary as revenue varies. This is true because it
is more difficult to change fixed costs than to change variable costs when unit sales change. If unit sales
decline, EBITDA and EBIT will drop more in a business where fixed costs represent a larger proportion
of total costs. Conversely, if unit sales increase, EBITDA and EBIT will increase more in a business with
higher fixed costs.

demONstratION prOBLem 10.1

Key point Students must have an intuitive understanding of a number of important principles and
forecasting eBIt
concepts to successfully
problem master the finance curriculum. We emphasise these important concepts
by presenting them in key point boxes. These boxes provide a statement of an important finance
You have decided to start a business that pro-
approach
Use the four-step procedure presented in the text to determine which projects you should accept.
vides in-home technical computer support to
concept, such as the relationship between risk and expected returns, along with an intuitive example
solution
people in the suburb near your university. You
Calculating the PI and ranking the projects from highest to lowest PI yields the following:
have seen national advertisements for a com-
or explanation topanyhelp thethese
student
services in ‘get’
other sub-the concept. These boxes help the students develop finance
Project Investment NPV @10% PI
that provides Buy new tool set $ 500 $1 000 $1 500/$500 = 3.000
urbs. You would run this business out of your
Buy employee training program 8 000 4 000 $12 000/$8 000 = 1.500

intuition. Collectively
room, and the key point boxeswho cover the most important concepts in corporate finance.
= 1.500
Paint existing cars 4 000 2 000 $6 000/$4 000
you know plenty of students
Buy used car 12 000 4 000 $16 000/$12 000 = 1.333
Buy new test equipment
have the necessary technical skills and would 10 000 2 000 $12 000/$10 000 = 1.200
Buy new notebook computer 3 000 500 $3 500/$3 000 = 1.167
welcome the opportunity to earn some pocket
Buy office building 40 000 5 000 $45 000/$40 000 = 1.125
money. To get up and running quickly, you
With $50 000 to invest, you should invest in all projects except the office building. This strategy will
would have to invest in a computer system, an
require $37 500 and is expected to result in a total NPV of $13 500. The $12 500 that you have left over
can be held in the business until an appropriate use for the money is identified, or it can be distributed
advertising campaign, three vehicles and tools.
to the shareholder (you).
You would also want to have enough cash to
keep the business going until it began to gen-
deCIsION-maKING erate positive
eX ampLe Decision-making example We emphasise the role
10.2 cash flows. All of this would require about $100 000, which is about all that you think you
can borrow on your credit cards, against your car, and from friends and family.
ranking investment alternatives
situation
You are of the financial manager as a decision maker. To that
now working on the financial forecasts for the business. You plan to charge $45 for house
calls lasting upapply
to only
30 tominutes and $25 for each additional 30 minutes. Since you expect that the typical
end, nearly every chapter includes decision-making
The profitability index concept does not a
company’s investments in projects. It can also apply to
house call will require 60 minutes, you expect it to result in revenue of $70. You also estimate that
your personal investments. For example, suppose that
monthly $50 000fixed operating
to invest it costs (FC) which include an advertising contract with a local radio station and
examples. These examples, which emphasise the
you have just inherited and want
in ways that create as much value as possible. After
a small
researching investment salaryyoufor
alternatives, you,
have identi-will total $3000. Unit VC, including the technicians’ pay, petrol and so forth, will
total
fied five investments that $20 for the
you believe typical
will have positive house call. Monthly depreciation and amortisation charges (D&A) will be $1000.
NPVs. You estimate that the NPVs and PIs for these
investments are as Finally, decision-making process rather than computation,
follows. you expect that after 6 months the business will average 120 house calls per month. Given this
information, what do you expect the monthly EBIT PIto be in 6 months?
Project
But a new car for your business
Investment
$20 000
NPV
$10 000
provide students with experience in financial decision
1.500
approach
Buy an apartment near campus 50 000 22 500 1.450
Start a small moving business 25 000 10 000
making.
1.400
Since EBIT = Revenue - VC - FC - D&A (see, for example, figure 10.5), you can forecast
Invest in your roommate’s internet business 15 000 5 000 1.333 Each decision-making example outlines a
the expected
monthly EBIT in 6 months by using this equation and the values for Revenue, VC, FC and D&A that you
Buy a collection of old comic books 5 000 1 000 1.200

expect in 6 months.
Which investment(s) should you choose? scenario and asks the student to make a decision
decision
solution
You should invest in the apartment. If you begin the selection process by choosing the new car because
The calculation is as follows:
it has the largest PI and then work your way down the list until you reach a total investment of $50 000,
based on the information presented.
you will see that you can invest in the car, the moving business and the comic books. These three
investments have a total NPV of $21 000. However, the investment in the duplex apartment alone has an
NPV of $22 500. Investing in the duplex apartment Revenue
will create more total value. $70 per house call × 120 calls $8400
This problem illustrates why the procedure for using PI to choose projects has four steps. Without the
- VC
fourth step, which tells us to repeat the third step $20 per
beginning with the second project, house
the third projectcall × 120 calls 2400
and so on, we would not have identified the apartment as the best alternative.
- FC 3000
- D&A 1000
Chapter 10 Evaluating project economics and capital rationing 361
EBIT $2000

c10EvaluatingProjectEconomicsAndCapitalRationing 361 13 January 2016 6:27 PM

Chapter 10 Evaluating project economics and capital rationing 345

that normal fluctuations in operating profits will lead to financial distress. Managers are also con-
SuMMaRY of lEaRning objECTiVES cerned with the impact of financial leverage on their reported profit, especially on a per-share
c10EvaluatingProjectEconomicsAndCapitalRationing 345 14 impact
basis. Finally, the December 2015 6:19
of capital PM decisions on who controls the company also affects
structure
14.1 Describe the two Modigliani and Miller propositions, the key assumptions underlying them,
capital structure decisions.
and their relevance to capital structure decisions.
M&M Proposition 1 states that the value of a company is unaffected by its capital structure if
the following three conditions hold: (1) there is no tax, (2) there are no information or trans-
action costs and (3) capital structure decisions do not affect the real investment policies of the KEY TERMS
company. This proposition tells us the three reasons that capital structure choices affect company
asset substitution problem the incentive that shareholders in a financially leveraged company have to
value.
substitute more risky assets for less risky assets
M&M Proposition 2 states that the expected return on a company’s equity increases with the
business risk the risk in the cash flows to shareholders that is associated with uncertainty due to the
amount of debt in its capital structure. This proposition also shows that the expected return on
characteristics of the business itself
equity can be separated into two parts — a part that reflects the risk of the underlying assets of the
company value or enterprise value the total value of the company’s assets; it equals the value of the
company and a part that reflects the risk associated with the financial leverage used by the com-
equity financing plus the value of the debt financing used by the company
pany. This proposition helps managers understand the implications of financial leverage for the
direct insolvency costs out-of-pocket costs that a company incurs when it gets into financial
cost of the equity they use to finance the company’s investments.
distress
14.2 Discuss the benefits and costs of using debt financing.
financial restructuring a combination of financial transactions that changes the capital structure of the
Using debt financing provides several benefits. A major benefit is the deductibility of interest pay- company without affecting its real assets
ments. Since interest payments are tax deductible and dividend payments are not, distributing cash financial risk the risk in the cash flows to shareholders that is due to the way in which the company
to security holders through interest payments can increase the value of a company. Debt is also has financed its activities
less expensive to issue than equity. Finally, debt can benefit shareholders in certain situations by indirect insolvency costs costs associated with changes in the behaviour of people who deal with a
providing managers with incentives to maximise the cash flows produced by the company and by company when the company gets into financial distress
reducing their ability to invest in negative NPV projects. insolvency costs or costs of financial distress costs associated with financial difficulties a company
The costs of debt include insolvency and agency costs. Insolvency costs arise because financial might experience because it uses debt financing
leverage increases the probability that a company will get into financial distress. Direct insolvency optimal capital structure the capital structure that minimises the cost of financing a company’s
costs are the out-of-pocket costs that a company incurs when it gets into financial distress, while activities
indirect insolvency costs are associated with actions the people who deal with the company take pecking order theory the theory that in financing projects, managers first use retained earnings, which
to protect their own interests when the company is in financial distress. Agency costs are costs they view as the least expensive form of capital, then debt, and finally externally raised equity, which
associated with actions taken by managers and shareholders who are acting in their own interests they view as the most expensive
rather than in the best interests of the company. When a company uses financial leverage, man- real investment policy the policy relating to the criteria the company uses in deciding which real
agers have incentives to take actions that benefit themselves at the expense of shareholders, and assets (projects) to invest in
shareholders have incentives to take actions that benefit themselves at the expense of lenders. trade-off theory the theory that managers trade off the benefits against the costs of using debt to
To the extent that these actions reduce the value of lenders’ claims, the expected losses will be identify the optimal capital structure for a company
reflected in the interest rates that lenders require. underinvestment problem the incentive that shareholders in a financially leveraged company have to
14.3 Describe the trade-off and pecking order theories of capital structure choice, and explain turn down positive NPV projects when the company is in financial distress
what the empirical evidence tells us about these theories.
The trade-off theory says that managers balance, or trade off, the benefits of debt against the
costs of debt when choosing a company’s capital structure in an effort to maximise the value
of the company. The pecking order theory says that managers raise capital as they need it in SuMMaRY of KEY EquaTionS
the least expensive way available, starting with internally generated funds, then moving to debt,
then to the sale of equity. In contrast to the trade-off theory, the pecking order theory does not Equation Description Formula
imply that managers have a particular target capital structure. There is empirical evidence that 14.1 Value of the company as the sum of the debt and VCompany = Vassets = VDebt + VEquity
supports both theories, suggesting that each helps explain the capital structure choices made by equity values
managers.
14.2 formula for weighted average cost of capital (WaCC) WaCC = xDebtkDebt + xoskos
14.4 Discuss some of the practical considerations that managers are concerned with when they for a company with only ordinary shares and no tax
choose a company’s capital structure.
Practical considerations that concern managers when they choose a company’s capital structure 14.3 Cost of ordinary shares in terms of the required return  VDebt 
kos = k assets +  (k − kDebt )
include the impact of the capital structure on financial flexibility, risk, profit and the control of the
on assets and the required return on debt  Vos  assets
company. Financial flexibility involves having the necessary financial resources to take advantage
14.4 Value of the tax savings of debt (upper bound) VTax-savings debt = D × t
of unforeseen opportunities and to overcome unforeseen problems. Risk refers to the possibility

498 part 4 Working capital management and financing decisions Chapter 14 Capital structure policy 499

Summary of learning objectives, key terms and key equations At the end of the chapter,
you will find a summary of the key chapter content related to each of the learning objectives
listed at the beginning of the chapter, a list of key terms introduced in the chapter, as well as a
list of the key equations in the chapter.

xvii HOW TO USE THIS RESOURCE

 SUMMARy OF KEy EQUATIONS
Equation Description Formula

12.1 Operating cycle Operating cycle = DSO + DSI

12.2 Cash conversion cycle Cash conversion cycle = DSO + DSI – DPO

12.3 Cash conversion cycle Cash conversion cycle = Operating cycle – DPO

12.4 Effective annual rate (EAR)  Discount 

365/ days credit
EAR =  1 + -1
 Discounted price 

12.5 Economic order quantity (EOQ) 2 × Reorder costs × Sales per period
EOQ =
Carrying costs

SELF-STUDy PROBLEMS Self-study problems Five problems similar

12.1 You are provided the following working capital information for Blue Ridge Ltd:
Account Beginning balance Ending balance
to the in-text demonstration problems follow
Inventory
Accounts receivable
$ 2 600
$ 3 222
$2 890
$2 800 the summary and provide additional examples
Accounts payable $ 2 500 $2 670
Net sales
Cost of sales
$24 589
$19 630
with step-by-step solutions to help students
If all sales are made on credit, what are the company’s operating and cash conversion cycles? further develop their problem-solving and
12.2 Merrifield Cosmetics calculates that its operating cycle for last year was 76 days. The company
had $230 000 in its accounts receivable account and sales of $1.92 million. Approximately how
many days does it take from the time raw materials are received at Merrifield Cosmetics until the
computational skills.
finished products they are used to produce are sold?
12.3 Below is a partial ageing of accounts receivable for Bitar Roofing Services. Fill in the rest of
the information and determine its days’ sales outstanding. How does it compare to the industry
average of 40 days?
Age of account (days) Value of account % of total account
0–10 $ 211 000
11–30 120 360
31–45 103 220
46–60 72 800
Over 60 23 740
Total $ 531 120

12.4 Rockhampton Ltd is looking to borrow $250 000 from its bank at an APR of 8.5 per cent. The
bank requires its customers to maintain a 10 per cent compensating balance. What is the effective
interest rate on this bank loan?

CRITICAL THINKING QUESTIONS

12.1 What factors must a financial manager consider when making decisions about accounts receivable?
12.2 List some of the working capital management characteristics you would expect to see in a
computer manufacturing company following just-in-time inventory practices.

Chapter 12 Working capital management 435

c12WorkingCapitalManagement 435 15 December 2015 7:20 PM

6.5 Highland Corporation Pty Ltd, an Australian company, has a 5-year bond whose yield to maturity
is 6.5 per cent. The bond has no coupon payments. The bond has a face value of $1000. What is
the price of this zero coupon bond?

Critical thinking questions At least CRITICAL THINKING qUESTIONS

6.1 You believe that you can make abnormally profitable trades by observing that the CFO of a
ten qualitative questions, called critical certain company always wears his green suit on days that the company is about to release positive
information about itself. Describe which form of market efficiency is consistent with your belief.
thinking questions, require students to 6.2 Describe the informational differences that separate the three forms of market efficiency.
6.3 What economic conditions would prompt investors to take advantage of a bond’s convertibility

think through their understanding of key feature?

6.4 Define yield to maturity. Why is it important?

concepts and apply those concepts to a 6.5 Define interest rate risk. How can CFOs manage this risk?
6.6 Explain why bond prices and interest rates are negatively related. What is the role of the coupon
rate and term to maturity in this relationship?
problem. 6.7 If rates are expected to increase, should investors look to long-term bonds or short-term
securities? Explain.
6.8 Explain what you would assume the yield curve would look like during economic expansion and why.
6.9 An investor holds a 10-year bond paying a coupon of 9 per cent. The yield to maturity of the
bond is 7.8 per cent. Would you expect the investor to be holding a par-value, premium or
discount bond? What if the yield to maturity were 10.2 per cent? Explain.
6.10 a Investor A holds a 10-year bond, while investor B holds an 8-year bond. If the interest rate
increases by 1 per cent, which investor will have the higher interest rate risk? Explain.
b Investor A holds a 10-year bond paying 8 per cent a year, while investor B also has a 10-year bond
that pays a 6 per cent coupon. Which investor will have the higher interest rate risk? Explain.

Questions and problems The questions qUESTIONS AND PROBLEMS

and problems, numbering 30 to 40 per
 BASIC |   MODER ATE |    CHALLENGING

 Basic

chapter, are primarily quantitative and 6.1 Bond price: AR Australasia Ltd is issuing a 10-year bond with a coupon rate of 8.89 per cent.
The interest rate for similar bonds is currently 5.97 per cent. Assuming annual payments and a
face value of $1000, what is the present value of the bond?
are classified as Basic, Moderate or 6.2 Bond price: Alex Simmonds just received a gift from her grandfather. She plans to invest in a
5-year bond issued by Nucorp Pty Ltd that pays annual coupons of 4.81 per cent. If the current
Challenging. market rate is 9.11 per cent, what is the maximum amount Alex should be willing to pay for this
bond? Assume it has a face value of $1000.
6.3 Bond price: Choice Pty Ltd has issued a 3-year bond with a face value of $1000 that pays a
coupon of 4.90 per cent. Coupon payments are made semiannually. Given the market rate of
interest of 4.70 per cent, what is the market value of the bond?
6.4 Bond price: National Australia Bank Ltd has 7-year bonds outstanding that pay a 11.03 per cent
coupon rate. Investors buying the bond today can expect to earn a yield to maturity of 6.72 per cent.
What is the current value of these bonds? Assume annual coupon payments and a face value of $1000.
6.5 Bond price: You are interested in investing in a 5-year bond with a face value of $1000 that pays
a 6.33 per cent coupon with interest to be received semiannually. Your required rate of return is
9.69 per cent. What is the most you would be willing to pay for this bond?
6.6 Zero coupon bonds: Chelsea Carter is interested in buying a 5-year zero coupon bond whose
face value is $1000. She understands that the market interest rate for similar investments is
7.96 per cent. Assume annual coupon payments. What is the current price of this bond?

Chapter 6 Bond valuation and the structure of interest rates 217

c06BondValuationAndTheStructureOfInterestRates 217 27 November 2015 7:19 AM

HOW TO USE THIS RESOURCE xviii

SELECTED ABBREVIATIONS
AND NOTATION
β= beta (a measure of systematic risk)
∆= change (e.g. DP = change in price level, DS = change in sales level)
ρ= correlation
σ2 (σ) = variance (standard deviation)
x= fractional weight of investment or component of capital
Add WC = addition to working capital
APR = annual percentage rate
ARR = accounting rate of return
C= coupon payment (bond)
Cap Exp = capital expenditures
CF = cash flow
CF Opns = cash flow from operations
CIP = call interest premium
CO = crossover level of unit sales
COS = cost of sales
CV = coefficient of variation
D= dividend (stock)
D&A = depreciation and amortisation
DOL = degree of operating leverage
DPO = days’ payables outstanding
DRP = default risk premium
DSI = days’ sales in inventory
DSO = days’ sales outstanding
E(•) = expected value (E(R) = expected return, etc.)
EAC = equivalent annual cost
EAR = EAY = effective annual rate (yield)
EBIT = earnings before interest and tax
EBITDA = earnings before interest, tax, depreciation and amortisation
EBT = earnings before tax
EFN = external funding needed
EOQ = economic order quantity
EROA = EBIT return on assets
F= face value (bond)
FC = fixed costs
FCF = free cash flows
FCFE = free cash flow to equity
FCFC = free cash flow from the company
FV = future value
FVAn = future value of an annuity
FXR = foreign exchange or currency risk premium
g= growth rate
i= nominal rate of interest
IGR = internal growth rate
IRR = internal rate of return
k= cost of capital (debt or equity)
m= number of payments per year
MAT = maturity adjustment to cost of a loan
MRP = marketability risk premium
MV = market value
n= number of periods
NCF = net cash flow
NCFOA = net cash flow from operating activities
NOPAT = net operating profits after tax
NPV = net present value
NWC = net working capital
OC = operating cycle
Op Ex = cash operating expenses
p= probability
P= price (P0 = price at time zero, etc.)
P/E ratio = price/earnings ratio
PB = payback period
PI = profitability index
PR = prime rate
PV = present value
PV annuity factor = present value of annuity factor
PVAn = present value of an annuity
r= real rate of interest
R= return (Rrf = risk free, Ri, RPortfolio, etc.)
ROA = return on assets
ROE = return on equity
SGR = sustainable growth rate
t= tax rate
TV = terminal value
V= value (e.g. VFirm = VAssets = VDebt + VEquity)
VC = variable costs
WACC = weighted average cost of capital

xx SELECTED ABBREVIATIONS AND NOTATION

PART 1
Introduction
1 The financial manager and the company 2

2 The financial environment and the level of interest rates 28

CHAPTER 1

The financial manager

and the company
LEA RN IN G OBJE CTIVE S

After studying this chapter, you should be able to:

1.1 identify the key financial decisions facing the financial manager of any company
1.2 identify the basic forms of business organisation used in Australia, and review their respective
strengths and weaknesses
1.3 describe the typical organisation of the financial function in a large company
1.4 explain why maximising the current value of the company’s shares is the appropriate goal for
management
1.5 discuss how agency conflicts affect the goal of maximising shareholder value
1.6 explain why ethics is an appropriate topic in the study of corporate finance.
Financial managers are continually faced with making decisions to maximise the current value of the
company’s shares. Geoff Babidge, CEO of the a2 Milk Company, is targeting developed markets rather
than the fast-growing Asian markets. This may appear to be odd considering many consumers are
reducing their intake of dairy. However, the a2 milk is not like other dairy products.
The a2 Milk Company produces dairy products from cows’ milk that contain only the A2 betacasein,
whereas most milk contains both A1 and A2 betacaseins. Studies have shown that A2-only milk digests
differently and is therefore a real solution for millions of people who have trouble digesting dairy
products. Mr Babidge said that competitors cannot easily mimic its process as it is secured by a series
of patents and trademarks. It is this unique feature of their products that differentiate a2 Milk Co. from
competitors.
The science behind a2 was identified in New Zealand but its success has been largely due to the
Australian market. Its fresh milk and infant formula sell at a premium even though Coles and Woolworths
sell home-brand milk for $1 per litre. The New Zealand company expanded into the Australian market
in 2007 and now supplies 9 per cent of the Australian fresh milk grocery channel by value. Mr Babidge
said he will fund moving into the United Kingdom and the United States from the solid base he’s built
in Australia. a2 plan on investing US$20 million in the US over the next three years.
Even though the company is listed in New Zealand, its stock began trading on the Australian Securities
Exchange on 31 March 2015 to boost the liquidity of a2 shares and broaden the potential investor and
capital base in case equity issues are required during this growth phase. The company is currently
investing heavily in starting up its business in the UK and US, and expanding its infant formula sales
in China, leaving little profit. In addition, a2 is considering launching cheese and ice-cream products
in Australia. Its priority, at this time, is growing the business. In 2013–14 a2 Milk reported revenue of
NZ$110.6 million ($108 million) and aims to more than double revenue to NZ$230 million by 2015–16.
Company managements use many of the concepts covered in this and later chapters to create the most
possible value. Managers create value by investing only in projects whose benefits exceed their costs, by
managing the assets of the company as efficiently as possible, and by financing the company with the

CHAPTER 1 The financial manager and the company 3

Another random document with
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“The same reason, with another. I attended to that. Every one who
knows this story of Shubar Khan must be reckoned with. I told them
that you must be kept alive—that I could secure your written
confession. They believe that I am at it now.”
Routledge was throwing the whole strength of his concentrated
faculties into the eyes of the old man. Cardinegh’s face was like
death.
“Where did you meet the secret agents?”
“At Naples. They had me on the carpet almost before I left ship.”
“This is the most absorbing tale I have ever encountered, Jerry. I am
to give you a written confession of how I fell in with the Russians and
gave them the documents concerning Shubar Khan, which I had
stolen. Why did you choose me to make this confession—because I
am your best friend?”
“Yes,” Cardinegh answered hoarsely; “because you are my best
friend. Not another man in the world would have carried the burden
for me. They would never have let me reach London.”
Routledge bent forward and spoke with lowered voice: “Then it was
you who fell in with the Russians——”
“Yes.”
Routledge couldn’t help it—the presence of the other put a poisoned
look into his face for an instant. The last fifteen minutes he had
endured every phase of astonishment and horror. The revelation
shook the psychic roots of his being.
“For the love of God, son—don’t look at me that way! Wait till I have
told you all. I thought you were already in London—with Noreen. I
was in Italy, and they never would have let me reach here. I never
could have seen her—or Cheer Street again.”
Pity came to Routledge. He looked down upon the wreck of Jerry
Cardinegh. He caught up his own nerve-ends and bound them
together, smiled, and placed his hand upon the old man’s knee.
“How often I have found it,” he said musingly, “that a day like
yesterday portends great events. I had the queerest sort of a day
yesterday, Jerry. Hour after hour I sat here, neglecting things which
needed doing, thinking, thinking. I have found it so before in my life
—days like yesterday preceding a crisis.... Weren’t any of the other
boys suspected, or any of the soldiers? Why was it that the finger of
the episode pointed to you or me?”
“Since October the whole occult force of the Empire has been upon
the case,” Cardinegh answered. “It was a civilian job on the face of it.
That was incontrovertible. All the other boys fell under the eyes of
the service. They didn’t know it, of course, but each day of the past
four months we have been covered, our pasts balanced. One after
another, the process of elimination vindicated them—all but you and
me. Your infernal habit of campaigning alone was against you, your
being an American, your Brahmin affiliations, your uncanny
knowledge of the Great Inside. Still, they took nothing for granted. At
Naples two agents drew me to cover, demanding what I knew. It was
you or I. They knew it, and I knew it. The bulk of suspicion leaned
your way. I shaped more evidence against you, hinted that I could
secure your confession, if they only let me alone until I could get to
you.”
“Tell me again just why, Jerry.”
“Because I wanted a day—just one day! I hadn’t seen Noreen for
nearly a year. I wanted a day with her. I needed to arrange her
affairs. God help me, Routledge, I wanted her to love the old man—
one more day! I couldn’t cable you. I thought—I thought you would
hold the weight one day—for old sake’s sake!”
“And what do you propose to do, Jerry?”
“I have had my day. I am going to the War Department with the facts
this morning!”
“And then?”
“Vanish.”
“And your daughter—Miss Noreen?”
Cardinegh swallowed with difficulty. His unsteady fingers fumbled at
the place where a man in the field carries a bit of ordnance. The
ghost of a smile shook itself out on his face.
“Don’t think I am sorry,” he said. “I joggled the seats of the mighty. It
was a life’s work. I’ve got my joy for it. It’s not what I expected—but
it’s done. I can’t see the good of it clear as I did—but it’s done. Only I
wanted to look it in the face like the old Jerry Cardinegh might have
done—not sick, shaking, and half-drunk. I should have done it when
the little house in Cheer Street only meant to me a sweet resting-
place between wars. I burned out before the end, my son.”
“But Noreen——”
“In the name of God, don’t drive that home again! She’ll never know
what the forty know. She’s provided for. I have had my day—thanks
to you. They’ll let me clear from England. I’m accustomed to take
short-notice trips, and to stay long. She will hear—as she always
feared some time to hear—oh, typhoid in Madagascar, a junk murder
up the Yangtse—potted somewhere!... Blessed little Noreen. In tears
she told me what had happened to you at the Armory. Think how I
felt, son. She loves you, Routledge. What—what I’ve done doesn’t
affect her value—in your eyes?”
“Jerry, how did you get away with this thing in India?”
“Nobody knows but me. I suppose I’d better tell you. Before my last
short trip home, there was a rumor of fighting in Afghanistan. You
remember, eight or nine British correspondents gathered there,
including you and me. Cantrell and I were rather close; and old
Abduraman, I think, trusted me more than any of the others, on
account of my age and service. He was an insatiable listener, and a
perfect, an improved, double-action pump. I think it was one of the
elements of his greatness—the wily old diplomat.
“Any way, I was closeted with him many times. You would come in at
night after studying the strategic points of that devil’s land; no doubt,
from Kabul to the Pass. For once in my life, I was content with office
work. I mean Abduraman’s court and his thoughts. Then, too, I was
much with Cantrell, who was a sort of secret-service chief in that
district, as you well understand. From time to time the different
agents would come in for a night—the men who do the dirty work for
England.”
Cardinegh’s eyes blazed again. With a few admirable sentences,
Routledge steadied him and regained the continuity....
“It was a still night, hot as hell,” Cardinegh went on. “Kabul can be
hot when the winds die down from the mountains—but you were
there that night. You know. I was in Cantrell’s house. Three of the
Nameless who serve England with their lives, and are satisfied with
a cipher message or a whispered word of praise from some head of
department——”
“I’ve studied the secret service, Jerry,” Routledge ventured mildly. “It
is interesting, but I’m more interested to know what happened.”
“We all proceeded to relax. The devil in me would not be burned by
the fieriest wines. Remember, Cantrell was a weak man, but sincere.
The other three had been studying Afghanistan against towering
odds. They knew more about the inner life of the Buffer State than
any three white men, not excepting Cantrell and yourself, between
Persia and British India. They were sure of Cantrell. As for old Jerry
Cardinegh—why, they took me for granted.
“Presently—it was very late—everybody but old Jerry had the bars
down and soaked. Then I ventured to open the question of Colonel
Hammond. It was an old story to Cantrell and to the three—not a
new story to me, but a strange one. I was fascinated by the inside
talk. Here were men who had kept the secret for years; the men—at
least, two of them—who had helped to scatter the British troops of
Colonel Hammond.
“Suddenly Cantrell arose and staggered to his safe, glancing at the
shut door and the open windows of the office. He fumbled with the
knob for a long time before the big door swung open. Then with
small keys which he found inside he got into the inner compartment
and drew forth a fat envelope.
“‘Speaking of Colonel Hammond,’ Cantrell said, with a drunken
smile, ‘I’ve got the whole documents here. They were never trusted
to the mails, but they trusted me. I’ve never brought them out before
—but we have fallen into the arms of our friends. Isn’t it so?’
“We all acquiesced, and then there was interesting reading.
Routledge, it was the great story I had been looking for—all that I
wanted to know about one of the most damnable military expeditions
ever transacted. I said to myself the world ought to know about this.
That was because I was a newspaper man. Then I said again, ‘The
world ought to know about this,’ and that was the humanitarian end. I
was thinking of Ireland and India.
“Two of the secret-service men were asleep finally. Cantrell moved
about and served on legs of hot wax.
“‘I’m glad you put that back in the safe, Cantrell,’ I said, when the
envelope was safely in my pocket. ‘You could do a lot of damage to
England with that just now.’
“I glanced at the secret agent who was awake, and found that he
was not in on my steal. I should have made a joke of it, if he had
been. The fact is, I did not really have the idea of stealing the papers
until I found that I had done it.... Cantrell locked the safe, and the
world was mine—all in a coat pocket!... You mind, when Cantrell was
killed, or assassinated, the safe was blown open—quite a while
afterward? I had been back to England and to Ireland with Noreen in
the meantime.
“God, how I have whipped the English!... When your name was
spoken last night at the Armory, the faces about me were like a lot of
blood-mad dogs—nostrils dilated and hackles up. I had to love you,
Routledge, to turn loose upon you—the Hate of London!”
“And you had the Hammond papers all the time you were in England
and Ireland?” Routledge inquired.
“Of course. I had only a few weeks in Europe before I was called
back to the Bhurpal skirmish-stuff. You had stayed in India——”
“But when and where did you get the papers to the Russian spies,
Jerry?”
“In Bhurpal—as that affair opened. It was weeks before I met you
that night of the gathering when the two British forces came together.
I stopped at the Rest House in Sarjilid, on the way by train from
Calcutta to the front. It was there I heard a Russian sentence from
an alleged Parsee. I was onto the spy in a moment, but first I want to
tell you why I turned over the papers to him. First, rather, I want a
drink of whiskey. I’m talking thick and fast, and it burns out the
energy.”
Routledge served him. “Why you gave Cantrell’s papers to the first
Russian spy you met in India is what I want to know,” he said
carelessly.
“Listen, then. The idea came to me before I went out to India on that
Bhurpalese mix-up. I told you that Noreen and I took a little trip to
Ireland. I shouldn’t have gone back to Tyrone—where her mother
bloomed—where I was a boy. I shouldn’t have gone back!”
The old man’s voice trembled, but he did not lose his point.
“As it was, my son, the thoughts of Noreen’s mother and Ireland
were burning too deep in memory.... But we went back. The sun was
going down on the little town. It was dirty, shrunken, decayed—that
old stone city—and the blithest place a youth ever met a maiden, or
passed his boyhood.... Ah, the mothers and youths and maidens and
the memories of old Tyrone always sung in my heart—when I could
forget England!”
Routledge lit a cigarette over the lamp and handed it to Cardinegh
without speaking. Jerry did not continue for a moment. Then followed
the impression his birthplace made upon him—the veteran with his
daughter:
“I can’t forget our last look—the old town, shrunken and silent in the
midst of her quarries. I heard the muttering in the doorways, as we
have heard it in India. The best blood had gone to America; the
knitting-works were shut down—the remnant starving. It was like
India in plague and famine, but I could have borne that.... It was the
next morning when I saw the British garrison quartered upon the
town——”
“You know how Colonel Hammond felt when something sprung a
leak in his brain,” Routledge suggested.
“You’ve hit it, boy.... There was the old town, starving at best, with
three hundred British soldiers devouring its substance! It made me
think of a fallen camel—with a red-necked vulture for every bone in
the carcass. And that’s Ireland and that’s India!”
The whiskey was bright in the old man’s eyes. “Look out, Routledge,
when you hear a snap in your brain! You said something to that
effect.... I went back to India, as you know, up from Calcutta to
Sarjilid, where I met the Russo-Parsee. I thought of Noreen and her
mother, and Tyrone, and the service of England, which I know as
well as you. I thought of India.
“What did I find in Sarjilid? There was a famine there, too, and a
garrison of red-necked vultures; sand blowing down from the windy
hills; stench from the huts; voices from the doorways; a salt-tax that
augmented the famine because the people needed but could not buy
their own product; naked brown children, fleshless as empty snake-
skins—but I won’t go on! I must go to the war-office presently.... It
was at Sarjilid that I met the Russian.... It may be that I am another
Colonel Hammond, but I gave the documents away. He was an
enchanting chap—that Russian!”
Cardinegh here whispered the details of his treachery. The politics of
the world would not be cleaned by the dialogue, but the big fact
remains that the documents concerning Colonel Hammond’s
dynamite went into Russian hands—a fire-brand for her to ignite
Afghanistan, the Indian Border, and British mutinies.
“Then I went back into the field to watch. Weeks passed,” he
continued hastily. “We met in Bhurpal, and you told me what you had
discovered. I knew. Each day was a brimming beaker of joy to me
then. I saw British India shudder at the broken vessel of her secrets.
“Routledge, it was as if you struck a viper in the spine. British India
curled up. I had struck her in the spine. She writhed and curled up!”
Cardinegh laughed again. “Ireland will be rid of British garrisons.
They will travel oversea to fight the Afghans and the Russians now.
The red-necks at Sarjilid won’t have to travel so far! There’ll be a
fifty-mile battle-front, as you said—you ‘amateur prophet’! You and
the other boys will campaign—but old Jerry won’t be there. I’ve had
my day—and this is another one. I’m off to lift your load, my son.”
The veteran campaigner arose and donned his coat. Routledge was
pacing up and down the room. Cardinegh reached the door, and,
holding to the knob, spoke again:
“I know what you think, my son. You think that my plan miscarried.
You think that England spoiled my work—that her treaty with Japan
was my answer. You think that England will rub away the rest of the
insulation between Russia and Japan, and that the Bear will fuse into
the Rising-Sun—that all this will pull Russia up from the border of
British India. Ah! ... and you think well. I can’t see it all as clear as I
did once. I can’t feel the thought of failure as I did once. England has
time to strengthen her borders and cover her nakedness if Russia
and Japan fight—but the story of Shubar Khan is told and my work
done! It’s the initial lesion, Routledge, and the veins of British India
are running with the toxin of a disease—sometimes amenable to
heroic treatment—like the Anglo-Japanese Alliance—but always
incurable!”
 SEVENTH CHAPTER
ROUTLEDGE BEGS FOR A STIMULANT—THE
STUFF THAT SINGS IN THE VEINS OF KINGS

Rain upon the windows. The atmosphere was heavy in the lodging,
heavy from a sleepless night. Tobacco ash upon the floor; white
embers in the grate; the finer ash of burned emotions in the eyes of
the men. Neither had spoken for several moments.... Whose was to
be the desolation of war? Was North China or China South soon to
rumble with the tramp of foreign armies? Routledge put the question
away among the far concerns of his mind. It was a moment now to
mourn the man before him. There never had been an instant of hate
for Jerry Cardinegh—perhaps, a full sweep of horror, at first, but that
was gone, and in its wake was a pity of permanence.
He mourned his friend who was mad, dead. The years had wrought
a ghastly trick here. Under many constellations, he had heard
Cardinegh whisper his passionate hatred for England and her
relation to Ireland and to India. Not a little of it Routledge himself
shared. He perceived now that this passion had devoured the reason
and sweetness of the old man’s mind. The Cardinegh of old days
looked no longer out of these hunted, red-lit eyes. A pestilence had
deranged the well-loved face. It was evil now in the fire-light—like a
tampered chart. A life of brooding had vanquished the excellent
humor at the last. Oppression had nursed a demon to obsess the
brain and make a shudder of a good name.
“I must go,” Cardinegh said roughly. “It is my last day. This morning
my final arrangements for Noreen. An hour with her—then to the
war-office with the revelation. You’ll stay here, son. Stick to these
walls—until Dartmore and the boys bring your glory back to you.... I
can see them trooping in!... And Noreen—ah, the gladness of her!”
Routledge opened wide the windows and stood by while the morning
swept in, damp, chill, but cleansing.
“Sit down a moment more, Jerry,” he said finally. “I want to ask a
favor of you. It is a hard thing, a delicate thing—harder and more
delicate than the thing you trusted to me, without asking. There is no
other white man whom I would dare ask such a favor.”
“Out with it, son.” Cardinegh watched him wonderingly. Routledge
sat down and leaned forward, a fine light in his big, calm eyes.
“I told you I had passed an interesting night, Jerry. It was more than
that—a wonderful night. Thoughts have come to me that never
squirmed in mortal brain before. I felt this vast moil of London—my
enemy! I felt it gathering about my ears like the Tai Fung in the China
sea. It was rich, incomparably rich, the stimulus of a Cæsar—this
Herod-hate of seven million souls! I’ve been thinking for hours, Jerry
—and I should have been writing—stuff for glory—the great book!
Whiskey wouldn’t bring out such work, nor drugs, nor Yogi
asceticism. I have glimpsed such work in stars, in battle-smoke, in
bivouac fires, in the calm and distances of the monster Himalayas;
perhaps in the eyes of women—but glimpses only, Jerry! To-night it
came like a steady stream of empyrean fire. I want months of it—
months! I would pay half my life to have London and the army hating
me this way until the work is done. It’s the stuff that sings in the veins
of kings. Give it to me—for the book!”
“Wake up! You fool—wake up!”
“Listen, old champion,” Routledge went on passionately: “I have
spent this life gathering the data of experience. I have crossed the
Sahara in the hue and garb of a camel driver; I have lain months a
yellow Mohammedan in the huts of Lahore; as a Sannyasi, I have
trudged up to the roof of the world. And the fighting, Jerry—Pathan,
Zulu, and Burmese; and the revolts—Afghan, Balkan, Manipur,
African, Philippine—all these came back, vivid, splendid last night—
pictures fit to gild and garnish the Romance of the Open. And, Jerry,
I have peered into the mystic lore of India, the World’s Mother—
subtly and enticingly to color it all! I want to do this, Jerry, the Book of
our Tribe! I shall write it in blood, with pillars of fire leaping up for
chapter-heads—if you will only leave this flood of power in my veins
—the Hate of London!”
Cardinegh, gasping, clutched his hand. “One of us—you or I—is mad
——”
“Mad, of course,” laughed Routledge. “A man must be a little mad
with the inspiration of Keats and the punch of Carlyle banging
together in his brain.”
Hope lived wildly now in Cardinegh’s eyes. “And while you are doing
the book,” he muttered, “I am to live out your tinsel and truffles here,
play the grizzled warrior—led about by the child of her mother....
Routledge—Routledge, your brand of stimulus is new and raw.”
“I’m tolerated to ordinary poisons, Jerry. A man immersed in gentle
azure can’t get the other pigments out of his brain.”
Cardinegh arose. “It’s sweet heaven to me,” he murmured strangely,
with quivering lips. “It is a rest such as I have never known. I never
was ready to rest until now, until to-day—when I thought the chance
was burned away. You want to take this?”
“Yes.”
“Months of life—Home, Noreen!... Damme, Routledge—I’m broken!
It’s like you, Routledge—it’s like you——”
“To me it’s a gift of the gods! Hold on, Jerry, until I bring back the
Book—hold on and sit tight!”
Cardinegh left the lodging and Bookstalls, bewildered by his new
possession of days. The strain that had kept him afoot until the end;
that had stiffened his body and faculties for the end itself; carrying
him step by step from the Khyber Hills, through the Bhurpal
campaign (the days in which he had watched the results of the fire
he had started); the strain that had roused his personal craft to baffle
and disarm those men of uncanny keenness at Naples, and pulled
him up for a last rally in London—was lifted now, and with it relaxed
the substance of his brain and body. Doubtless, he would have
preserved his acumen upstanding, and an unsnapped nerve, to bid
Noreen farewell and make his confession at the War-Office to-day—
but there was no need!
The old man walked along mumbling, forgetting the while to hail a
cab. The miracle of it all, though it did not appeal to him, was that he
had lost his ruling, destroying hatred for England. Cheer Street and
Noreen—the blessedness of her hand to help him; her touch so like
her mother’s upon his brow; the eyes of her mother across the table
—months of life, of rest, of Home and Noreen!... These were his
thoughts. There was no room for world-politics, for war, for passion.
Even the thing which Routledge had done hovered in the
background. It was a piece of inhuman valor, almost too big to hold
fast to. Routledge was identified in his brain now with the stirring
braveries of days long gone; with other sunlights in which men met
the shock of things in full manhood; it was of another, of a ruddier,
world to old Jerry’s eyes to-day.... In a remote way, he felt that once
he might have revelled in the hate of London. Perhaps it was one of
the things peculiar to the middle distances of manhood—as far from
the comprehension of the elders as of the children. That there was
an element of sacrifice in the action of Routledge was not entirely
lost to Cardinegh, but he put it away among the misty glories of
memory—days when manhood was in its zenith of light and power. It
was not of the present; it had nothing to do with the numbness and
the swift, painless softening of to-day.
“Noreen!” he called, at the front door in Cheer Street.
A servant told him that Noreen had been away for an hour.... With a
startled look, the servant drew a chair close to the fire for the old
man, poured a grog for him, set his smoking things to hand, and
backed staring out of the room.... Hours afterward, Noreen found him
there—the glass, the pipes, the daily papers untouched. His smile
was like something which the wind had blown awry. His eyes were
depleted of fire, of fury. Even the starry worship which her presence
had reflected in them yesterday was dimmed—as were the mighty
images of the wars in his brain.... He roused at the sight of her,
started to speak of Routledge, halted, reflected, then drank.
“Hold a match to my pipe, child. It was your mother’s way. You’ve
been gone the long while, deere.”
She obeyed. The majesty of pain was upon her face as she hurried
away. Locked in her own room, long afterward, she heard him
humming quaveringly an old Irish folk-song—lost from her brain a
dozen years.
 EIGHTH CHAPTER
THE SUPERLATIVE WOMAN EMPTIES HER
HEART OF ITS TREASURES FOR THE OUTCAST,
AND THEY PART AT CHARING CROSS

After taking the hand of Jerry Cardinegh at the stairs, Routledge

returned to his room, smiling a trifle bitterly.
“That was certainly a fragile underpinning to rear a great lie upon,”
he mused. “I couldn’t have made old Jerry swallow that a year ago....
But there’s good humor in the idea—the book of Routledge
energized by the dynamos of British hate—a book of wars from a
man who rather likes to promote the ranking rottenness of war.... But
the name of Cardinegh cannot go down just yet with that of Colonel
Hammond, and the Lotus Expedition; with treachery.... Living God,
how that sweet girl haunts me!... I must put her away—far back
among the cold, closed things. It isn’t fair to use her as a trellis for
thought-vines like mine. She is just psychic enough to know, without
words——”
He thought presently of what Rawder had told him about returning to
India this year; also of Noreen’s amendment—that he was to go very
quickly. How far off it had seemed yesterday!... Routledge was
standing at the window. Though his active mind was filled with
sadder, finer matters, a process of unconscious cerebration was alert
for the White Mustache in the street below. This certain secret agent
was not in sight, but there was not a single individual of the throng
who might not be identified with that silent, fameless department—
the men who had kept the secret of Shubar Khan in spite of Colonel
Hammond’s regiment, which knew all.... London was running with its
sordid morning business—grinding by in the gray morn and the rain.
“London,” he exclaimed softly, marvelling at the great thing which
had befallen him, “the keyboard of the planet! How the Excellent
Operator hungers to turn the full voltage on me now!”
Routledge was hard-hit, and made no pretenses to himself
otherwise. He did not want to go back to India to-day. The thing he
had managed to pray for—the Hate of London—was a crippling
horror. It tore down the inner life of him. He felt already the
encompassing loneliness of an expatriate; worse, he felt against him
the gigantic massed soul of the English. It peopled the shadows of
the room and the street and his brain, filling him with weakness and
faltering. It was not that the idea of death hung to the flanks of his
being. He could laugh at death with a sterling principle. Rather, it
was that all that had bound him to life was dead—work and play and
light. He was chained to a corpse—the hate of London. It was an
infectious corrosion which broke his own spirit, as no physical dread
had ever done; yet, stricken as he was, he felt himself torn in the
counter-attraction of two great passions—between his sweetest
woman and his bravest man.... A light rapping at his inner door
startled him. It was the Bookstalls boy.
“Kin I come out now, Mister?”
With a gasp of relief, Routledge turned to the door; but, on the way,
his eyes fell upon the two worn, fallen-in shoes, set so evenly before
the fire.
“Bless you, lad—just a minute,” he said.
He gathered up all the change his pockets had held, big and little
pieces of silver, and dropped them softly into the shoes, now stiffly
dried,—then opened the door. The small, draggled chap emerged
briskly, took in his host from head to foot with a quick, approving
look, then glanced out of the window to locate himself. It was all
coming back to him apparently.
“I was sleepin’ in yer street-stairs,” he explained, as if to get it
straight in his own mind. “Then I didn’t know nothink till I ’eerd
woices.”
“What’s your name, little soul?”
“Johnny Brodie.”
“Did the voices bother you, Johnny?” Routledge asked.
“Naw. I was too warm. Nothink like woices never bothers when
you’re warm. Is them your stairs? Nobody never come up them stairs
late afore.”
“Have you slept there often, Johnny?”
“Not wery,” the boy said nervously.
He had given Routledge a start for a moment. It was not past the
White Mustache to have used a lad of this size, but, once used, the
lad would never have spoken of “woices.” Besides, he had slept on
the stairs before. Johnny was looking about the walls with covert
appreciation. Guns, saddles, and soldier-pictures appealed to him.
They were proper man-things.
“How long have you been in Bookstalls, and around here?”
“Allus.”
“But haven’t you any place to sleep?”
“Lots.” It wasn’t said with humorous intent. Johnny Brodie was
struggling with his shoes.
Routledge regarded him with joy.
“Lor-gordy,” muttered Johnny, in an awed voice. “Wishermay die if
you ain’t tipped over a bank in me boots!... Mine?”
Routledge nodded.
“Well, I’m chivvied! I ’ont be safe nowheres wit all this.”
“Johnny, are all your places to sleep like my stairs? I mean, haven’t
you any regular place?”
The boy gave him a quick glance and decided that this was not the
time for lies.
“Lor-gordy—them stairs ain’t bad—on’y wen it’s wery cold. Naw, I
ain’t got nothink reg’lar.”
“There’s a bit of a room just your size, Johnny, in the back-hall,” the
man said. “I’m going away again to-day, and these rooms will be
locked up for a long time, but I’ll be back, I think. If I were to fix it with
the good landlady for you to have that little room—and I’ll give you a
regular army blanket like the soldiers have, to curl up in when it’s
cold, and a little cot, and all the things you need—would you use it
every night?”
“Lor’! Say, Mister, honest?”
He nodded. “Run along then, Johnny, and get a good breakfast, and
I’ll have it arranged when you get back.”
Routledge came to an agreement with the woman of the house;
carried from his own rooms blankets, soap, towels, pictures, a pair of
military brushes, an unused pocket-knife, a package of candles, and
many other little things to the wee box of a room in the hall, taking
much pleasure in the outfitting.... He had not yet brought his own
baggage from Charing Cross, and was glad now. London had
become to him like a plague quarantine, a smothering menace. He
would leave London to-day, and Noreen Cardinegh, without daring to
see her again. His every movement, he realized, was watched. Even
to take her hand for a moment would reflect evil upon her. The White
Mustache, or one of his kind, would observe, and a lasting record
would be made. He paced the floor swiftly, murdering the biggest
thing in his life.
... He could go to Rawder. There was healing in that. Perhaps the old
Sannyasi would take him for the chela of his chela. He could hide in
England’s India, which only a few of the secret service knew so well
as he.... Could he put all the wars and illusions of matter away, drink
of the ancient wisdom, wander beneficently until the end, with two
holy men, in the midst of God’s humblest poor? Could he put behind
him all that was supreme and lovely of his life this hour, sink it in the
graveyard of his past with other dead desires?
It was just a rush of vague, vain thoughts. Had he been pure as the
boy, twelve years ago, and wise as the man now, and if he had never
known Noreen Cardinegh, possibly then the old Sannyasi might say,
“Be the disciple of my disciple; and, free from all the illusions of the
flesh, journey with us up into the silence of the goodly mountains.”...
But this life would never know freedom from that thrilling, beautiful
memory. He could sacrifice a union with Noreen Cardinegh, but
never renounce her from the high place of his heart. She was
wedded to the source and centre of his life, and no asceticism could
shrive her from him. He might put half the planet’s curve between,
but the bride the world had formed for him would be the eternal
crying voice in the wilderness; and until they were mated in this or
another life, the Wheel of Births and Deaths would never whirl him
free from love, the loftiest of all illusions. Though he sat in a temple
upon the roof of the world, holding his thoughts among the stars until
the kusa grass beneath him was blown like dust away, and his body
petrified upon the naked rock, the last breath from the ruin would stir
his lips to the name of the world’s bright gift to him—Noreen.
Johnny Brodie returned. Routledge took him by the hand and led him
into the midst of his possessions.... It was quite a happy time, with
the old landlady looking on, and a mysterious fund in her pocket for
Johnny stockings, and Brodie trousers and even dinners, when old
Bookstalls was remiss in her duty. Finally, at the last moment,
Routledge dropped his hand upon the boy’s shoulder. The face was
turned up clear, the eyes unblinking. The man was no longer afraid.
“Johnny,” he said, “the best fellows in this world are those who are
strong enough to hold their tongues at the right time. Nobody must
know about this little room—nobody. To you, I’m just a decent
stranger who has gone away. If anybody asks who or where or how
or why about me—you don’t know. This is all yours. Sleep tight, and
say nothing. If you need anything that you can’t get yourself, go to
the landlady. Be clean about what you do everywhere—I don’t mean
in the room, Johnny, but everywhere, in the street, too. Not clean
about your hands and face—that’s good—but mostly about what you
think. I may come back some time, and I may not, but you’ll be fixed
here as long as you need. Think of it, Johnny Brodie—remember this
well: always if something hits you from inside that a thing isn’t good
to do, don’t hurry about doing it. Think it over. If you wouldn’t do it
when the person you like best in the world is watching, it isn’t a good
thing to do alone.”
Routledge locked his lodgings. With the boy attached to one hand
and his bag in the other, he went down into the street, and just at
that moment a carriage opened at the curb, and Noreen Cardinegh
stepped out. Routledge took the outstretched hand, but there was a
warm flood of pain widening within him, as blood from an opened
wound....
The rain-coat hung about her like a delicate harmony, its hood
covering her hair; and its high-rolling collar, bound with scarlet, thin
as a thread but vivid as an oriflamme, concealed her throat. That
lustrous, perfect oval face in the rain. It was luminous from within like
a pearl, and had its scarlet-edging in the curving, exquisite lips,
strange with inner vividness. Never had she been so wondrous to
him as he felt the superb zest of life beneath the pearl-gray glove
that moment in grimy Bookstalls. A conception of womanhood that
widened the limitations of any man!... He lifted his glance from the
pavement, where it had been held for an instant by the glittering
point of her boot, and found the great eyes upon him—pools of
splendor which held his temple, white as truth, golden sunlight on its
dome; and, far within, a dim, mystic sanctuary where Mother Earth
had built a shrine for him.
“Thank God you have not gone, Routledge-san!” she said in a low
way. “Tell me—ah, but I know—you would have gone without a word
to me.... You think it is right?”
“Yes.”
“Why do you punish me this way, Routledge-san?... Do you think I
mind what London cares or thinks? Do you think London could force
me to believe ill of you?... I must talk with you! May we not go up into
your rooms, out of the crowd and the rain? The little boy may come.”
There was not a window commanding the street which might not
have held the White Mustache that moment; not a single passer-by
who might not have been one of his kind.
“I have turned in my—that is, I have given up my room,” he faltered.
“I must talk with you. Come into my carriage. That will be the better
way. The little boy——”
She caught the look of hostility in the street-waif’s eyes. She was
taking the man away. There was another look, the meaning of which
she did not miss. Routledge bent down to him.
“Good-by, little soul,” he said. “I’ll find you in some doorway again
some time—maybe in the doorway to fame. Be a good little fellow
always. Don’t get tired of being clean, and some time you’ll be
mighty glad.”
The boy watched the carriage move slowly away among the
truckage—until a stranger put a hand upon his shoulder.

For many seconds neither spoke; then it was Noreen.

“What is this big thing you are doing, Routledge-san?”
“I cannot tell—even you.”
“Yes, but you need not have hurt me so. You were going away
without a word to me—and I am so proud to have been for you—
against the others.”
“Noreen, you must believe that it is not good for you to be seen with
me now. Every movement I make is known; everyone in the slightest
communication with me is under suspicion. Your loyalty—I cannot
even speak of steadily, it is so big and dear—and because it is so, I
shudder to drag you into these forlorn fortunes of mine. It is in the
power of these people to make you very miserable while I am gone
—and that is anguish to me, nothing less.”
“You think of me—think of me always, and a little social matter which
concerns me!” she exclaimed. “I care nothing for it—oh, please
believe that. Last night you left the Armory, not knowing what had
befallen you. This morning you know all. Could you have done
unconsciously—anything to turn the Hate of London upon you?... It