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Course Essentials of Corporate
Finance
Course Number 3rd Edition
Ross/Trayler/ Bird/Westerfield
Jordan
2 Essentials of Corporate Finance
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National Library of Australia Cataloguing-in-Publication Data

Title: Essentials of corporate finance/ Stephen A. Ross [et al.].
Edition: 3rd ed.
ISBN: 9780071013185 (pbk.)
Notes: Includes index.
Subjects: Corporations—Finance. Industrial management.
Other Authors/Contributors: Ross, Stephen A.
Dewey Number: 658.15
Published in Australia by
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Essentials of Corporate Finance, Third Edition 3
ESSENTIALS OF
CORPORATE FINANCE
3RD EDITION
STEPHEN A. ROSS
Massachusetts Institute of Technology
ROWAN TRAYLER
University of Technology Sydney
RON BIRD
University of Technology Sydney
RANDOLPH W. WESTERFIELD
University of Southern California
BRADFORD D. JORDAN
University of Kentucky
ASSURANCE OF LEARNING
Assurance of learning is an important element of many accreditation standards. The third edition of Essentials of
Corporate Finance is designed specifically to support your assurance of learning initiatives.
Each chapter in the book begins with a list of numbered learning objectives that are aligned with the end-of-
chapter problems and exercises. Every testbank question is also linked to one of these objectives, in addition to
level of difficulty, topic area, Graduate Attributes,1 EQUIS and AACSB skill areas.
AACSB STATEMENT
McGraw-Hill Education (Australia) Pty Ltd is a proud corporate member of AACSB International. Understanding
the importance and value of AACSB accreditation, the third edition of Essentials of Corporate Finance has sought
to recognise the curriculum guidelines detailed in the AACSB standards for business accreditation by connecting
selected questions in the testbank to the general knowledge and skill guidelines found in the AACSB standards.
The statements contained in the testbank are provided only as a guide for the users of this text. The AACSB
leaves content coverage and assessment within the purview of individual schools, the mission of the school, and
the faculty. While Essentials of Corporate Finance and the teaching package make no claim of any specific AACSB
qualification or evaluation, we have, within the testbank, labelled selected questions according to six general
knowledge and skills areas.2
1 DEST 2002a, Employability skills for the future, Department of Education, Science and Training, Commonwealth of Australia.
2 AACSB International 2008, Eligibility procedures and accreditation standards for business accreditation, www.aacsb.edu.
iv
BRIEF CONTENTS
PART 1 OVERVIEW OF FINANCIAL MANAGEMENT 1

Chapter 1 Introduction to financial management 2
PART 2 UNDERSTANDING FINANCIAL STATEMENTS AND CASH FLOW 23

Chapter 2 Financial statements, taxes and cash flow 24
Chapter 3 Working with financial statements 52
PART 3 VALUATION OF FUTURE CASH FLOWS 93

Chapter 4 Introduction to valuation: The time value of money 94
Chapter 5 Discounted cash flow valuation 118
PART 4 VALUING SHARES AND BONDS 157

Chapter 6 Interest rates, bill and bond valuation 158
Chapter 7 Equity markets and share valuation 202
PART 5 CAPITAL BUDGETING 227

Chapter 8 Net present value and other investment criteria 228
Chapter 9 Making capital investment decisions 262
PART 6 RISK AND RETURN 295

Chapter 10 Some lessons from capital market history 296
Chapter 11 Risk and return 332
PART 7 LONG-TERM FINANCING 369

Chapter 12 Cost of capital 370
Chapter 13 Leverage and capital structure 398
Chapter 14 Dividends and dividend policy 430
Chapter 15 Raising capital 454
PART 8 SHORT-TERM FINANCIAL MANAGEMENT 475

Chapter 16 Short-term financial planning 476
Chapter 17 Working capital management 508
PART 9 TOPICS IN BUSINESS FINANCE 535

Chapter 18 International aspects of financial management 536
CONTENTS
Acknowledgments xiv Digital resources xviii
Preface xv Highlights of this edition xx
About the original authors xvi Text at a glance xxiv
About the Australian authors xvii
PART ONE OVERVIEW OF FINANCIAL MANAGEMENT

CHAPTER 1 INTRODUCTION TO FINANCIAL MANAGEMENT 2
1.1 Finance: a quick look 3 Finance matters: Corporate ethics 11

The four basic areas 3 Corporate governance 12
Why study finance? 4
1.5 The agency problem and control
1.2 Business finance and the financial manager 5 of the corporation 13
What is business finance? 5 Agency relationships 13
The financial manager 5 Management goals 13
Financial management decisions 6 Do managers act in the shareholders’ interests? 13
Stakeholders 15
1.3 Forms of business organisation 7
Sole proprietorship 8 1.6 Financial markets and the corporation 16
Partnership 8 Cash flows to and from the firm 16
Corporation 8 Primary versus secondary markets 17
A corporation by another name . . . 9 Summary and conclusions 18
Critical thinking and concepts review 19
1.4 The goal of financial management 10
What’s on the web? 20
Profit maximisation 10
Mini-case: The Ozzie Cake Company 21
The goal of financial management in a corporation 11
A more general financial management goal 11
PART TWO UNDERSTANDING FINANCIAL STATEMENTS AND CASH FLOW

CHAPTER 2 FINANCIAL STATEMENTS, TAXES AND CASH FLOW 24
2.1 The balance sheet 25 Taxation of dividends: Difference between a classical tax
Assets: the left-hand side 25 system and an imputation system 35
Liabilities and owners’ equity: the right-hand side 25
2.4 Cash flow 36
Net working capital 26
Cash flow from assets 37
Liquidity 27
A note on ‘free’ cash flow 39
Debt versus equity 27
Cash flow to creditors and shareholders 39
Market value versus book value 28
Conclusion 39
2.2 The income statement 29 An example: cash flows for Apple Isle 40
AAS and the income statement 30 Summary and conclusions 42
Finance matters: A blow for Rio Tinto’s shareholders 31 Chapter review and self-test problem 43
Non-cash items 31 Critical thinking and concepts review 45
Time and costs 32 Questions and problems 45
Earnings management 32 What’s on the web? 49
Mini-case: Cash flows and financial statements at
2.3 Taxes 34
Byron Bay Boards Ltd 50
Corporate tax rates 34
Average versus marginal tax rates 34
vi
CHAPTER 3 WORKING WITH FINANCIAL STATEMENTS 52
3.1 Standardised financial statements 53 ROA, ROE and growth 70

Common-size balance sheets 53 Finance matters: Growing: how fast is too fast? 71
Common-size income statements 54
3.5 Using financial statement information 73
3.2 Ratio analysis 56 Why evaluate financial statements? 73
Short-term solvency, or liquidity, measures 57 Choosing a benchmark 74
Long-term solvency measures 58 Problems with financial statement analysis 77
Asset management, or turnover, measures 60 Finance matters: What is in a ratio? 78
Profitability measures 62 Summary and conclusions 78
Market value measures 63 Chapter review and self-test problems 79
3.3 The Du Pont identity 65
Questions and problems 82
An expanded Du Pont analysis 67
3.4 Internal and sustainable growth 68 Mini-case: Ratios and financial planning at Kiwi Yachts Ltd 90
Dividend payout and earnings retention 68
PART THREE VALUATION OF FUTURE CASH FLOWS

CHAPTER 4 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY 94
4.1 Future value and compounding 95 Finance matters: A quack investment? 107
Investing for a single period 95 Finding the number of periods 109
Investing for more than one period 95 Summary and conclusions 112
Chapter review and self-test problems 113
4.2 Present value and discounting 101
The single-period case 101
Present values for multiple periods 102
4.3 More on present and future values 104
Present versus future value 105
Determining the discount rate 105
CHAPTER 5 DISCOUNTED CASH FLOW VALUATION 118
5.1 Future and present values of multiple Calculating and comparing effective annual rates 136
cash flows 119 EARs and APRs 138
Future value with multiple cash flows 119 EARs, APRs, financial calculators and spreadsheets 138
Present value with multiple cash flows 122
5.4 Loan types and loan amortisation 139
Finance matters: Jackpot! 123
Pure discount loans 139
A note on cash flow timing 125
Interest-only loans 140
5.2 Valuing level cash flows: annuities Amortised loans 140
and perpetuities 126 Summary and conclusions 144
Present value for annuity cash flows 127 Chapter review and self-test problems 144
Future value for annuities 132 Critical thinking and concepts review 146
A note on annuities due 132 Questions and problems 147
Perpetuities 133 What’s on the web? 154
Mini-case: Kiwi Yachts’ mortgage 155
5.3 Comparing rates: the effect of compounding
periods 135
Effective annual rates and compounding 136
CONTENTS vii
PART FOUR VALUING SHARES AND BONDS

CHAPTER 6 INTEREST RATES, BILL AND BOND VALUATION 158
6.1 Bills of exchange and bill valuation 159 Floating-rate bonds 181
Bill of exchange, features and pricing 159 Other types of bonds 181
Bill values and yields 160 Finance matters: Exotic bonds 182
More on bill features 161
6.7 Bond markets 183
6.2 Other short-term funding instruments 162 How bonds are bought and sold 183
Bond price reporting 184
6.3 Bonds and bond valuation 162
Bond features and prices 163 6.8 Inflation and interest rates 188
Bond values and yields 163 Real versus nominal rates 188
Interest rate risk 166 The Fisher effect 188
Finding the yield to maturity: more trial and error 168
6.9 Determinants of bond yields 190
Finance matters: Reserve Bank of Australia bond
The term structure of interest rates 190
pricing formula 172
Bond yields and the yield curve: putting it all together 192
6.4 More on bond features 173 Conclusion 193
Is it debt or equity? 173 Summary and conclusions 194
Long-term debt: the basics 173 Chapter review and self-test problems 194
The trust deed 174 Critical thinking and concepts review 195
6.5 Bond ratings 178
6.6 Some different types of bonds 180 Mini-case: Financing Kiwi Yachts Ltd expansion
Government bonds 180 plans with a bond issue 200
Zero coupon bonds 180
CHAPTER 7 EQUITY MARKETS AND SHARE VALUATION 202
7.1 Ordinary share valuation 203 7.3 The share markets 216
Cash flows 203 Dealers and brokers 216
Some special cases 204 Organisation of the ASX 217
Components of the required return 209 Share market reporting 218
Share valuation using multiples 210 Summary and conclusions 219
7.2 Some features of ordinary
and preference shares 212
Ordinary share features 212
Shareholders’ rights 212
Mini-case: Share valuation at Gold Coast Constructions 226
Preference share features 214
Finance matters: Owners’ benefits? 215
PART FIVE CAPITAL BUDGETING

CHAPTER 8 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 228
8.1 Net present value 229 Redeeming qualities of the rule 236
The basic idea 229 Summary of the rule 236
Estimating net present value 230 8.3 The average accounting return 237
8.2 The payback rule 232 8.4 The internal rate of return 239
Defining the payback rule 232 Problems with the IRR 242
Analysing the payback rule 235 Redeeming qualities of the IRR 245
viii CONTENTS
The modified internal rate of return (MIRR) 246 Chapter review and self-test problems 251
The profitability index 247
The practice of capital budgeting 248 What’s on the web? 260
Summary and conclusions 251 Mini-case: Cadia East Gold Mines 261
CHAPTER 9 MAKING CAPITAL INVESTMENT DECISIONS 262
9.1 Project cash flows: a first look 263 An example: the Majestic Mulch and
Relevant cash flows 263 Compost Company (MMCC) 273
The stand-alone principle 263 Conclusion 276
9.2 Incremental cash flows 264 9.5 Evaluating NPV estimates 279
Sunk costs 264 The basic problem 279
Opportunity costs 264 Finance matters: When things go wrong . . . 280
Side effects 264 Sources of value 280
Net working capital 265
9.6 Scenario and other what-if analyses 281
Financing costs 265
Getting started 281
Other issues 265
Scenario analysis 282
9.3 Pro forma financial statements Sensitivity analysis 283
and project cash flows 266
9.7 Additional considerations in capital budgeting 284
Getting started: pro forma financial statements 266
Managerial options and capital budgeting 284
Project cash flows 267
Capital rationing 286
Projected total cash flow and value 268
Summary and conclusions 287
The tax shield approach 269
9.4 More on project cash flow 269 Critical thinking and concepts review 289
A closer look at net working capital 269 Questions and problems 290
Depreciation 271 Mini-case: Emu Electronics 294
PART SIX RISK AND RETURN

CHAPTER 10 SOME LESSONS FROM CAPITAL MARKET HISTORY 296
10.1 Returns 297 Using capital market history 315

Dollar returns 297 More on the stock market risk premium 316
Percentage returns 299
10.5 More on average returns 318
10.2 The historical record 301 Arithmetic versus geometric averages 318
A first look 302 Calculating geometric average returns 318
A closer look 302 Arithmetic average return or geometric average return? 319
10.3 Average returns: the first lesson 307 10.6 Capital market efficiency 320
Calculating average returns 307 Price behaviour in an efficient market 320
Average returns: the historical record 307 The efficient markets hypothesis 321
Risk premiums 307 Some common misconceptions about the EMH 322
The first lesson 308 The forms of market efficiency 323
Implications of the EMH for corporate finance 324
10.4 The variability of returns: the second lesson 308
Frequency distributions and variability 309
The historical variance and standard deviation 310
The historical record 311
Normal distribution 312
The second lesson 314
Mini-case: A job at Kiwi Yachts 330
2008: The bear growled and investors howled 315
CONTENTS ix
CHAPTER 11 RISK AND RETURN 332
11.1 Expected returns and variances 333 Diversification and systematic risk 345
Expected return 333
11.6 Systematic risk and beta 346
Calculating the variance 335
The systematic risk principle 346
11.2 Portfolios 337 Measuring systematic risk 347
Portfolio weights 337 Finance matters: Beta, beta, who has the beta? 349
Portfolio expected returns 337 Portfolio betas 349
Portfolio variance 338
11.7 The security market line 350
11.3 Announcements, surprises and Beta and the risk premium 350
expected returns 340 The security market line 355
Expected and unexpected returns 340
11.8 The SML and the cost of capital: a preview 358
Announcements and news 340
The basic idea 358
11.4 Risk: systematic and unsystematic 342 The cost of capital 358
Systematic and unsystematic risk 342 Summary and conclusions 358
Systematic and unsystematic components of return 342 Chapter review and self-test problems 359
11.5 Diversification and portfolio risk 343
The effect of diversification: another lesson from
market history 343
Mini-case: The beta for Coca-Cola Amatil Ltd 367
The principle of diversification 344
Diversification and unsystematic risk 344
PART SEVEN LONG-TERM FINANCING

CHAPTER 12 COST OF CAPITAL 370
12.1 The cost of capital: some preliminaries 371 Finance matters: EVA: an old idea moves into
Required return versus cost of capital 371 the modern age 382
Financial policy and cost of capital 372 Calculating the WACC for JB HI-FI Ltd 384
12.2 The cost of equity 372 12.5 Divisional and project costs of capital 387
The dividend growth model approach 372 The SML and the WACC 387
The SML approach 374 Divisional cost of capital 388
12.3 The costs of debt and preference shares 376 The pure play approach 388
The cost of debt 376 The subjective approach 389
The cost of preference shares 377 Summary and conclusions 390
12.4 The weighted average cost of capital 377
The capital structure weights 377
Taxes and the weighted average cost of capital 378
Taxes and the weighted average cost of capital
Mini-case: Cost of capital for Hubbard Computer Ltd 397
(imputation tax system) 379
Solving the warehouse problem and similar
capital budgeting problems 381
CHAPTER 13 LEVERAGE AND CAPITAL STRUCTURE 398
13.1 The capital structure question 399 13.3 Capital structure and the cost of equity capital 405
M&M Proposition I: the pie model 405
13.2 The effect of financial leverage 400
The cost of equity and financial leverage:
The impact of financial leverage 400
M&M Proposition II 405
Corporate borrowing and homemade leverage 403
Business and financial risk 407
x CONTENTS
13.4 Corporate taxes and capital structure 407 Optimal capital structure and the cost of capital 414
The interest tax shield 408 Capital structure: some managerial recommendations 417
Taxes and M&M Proposition I 409 13.7 Observed capital structures 417
Capital structure and dividend imputation 410
Dividend imputation and the effect on the 13.8 A quick look at the bankruptcy process 420
interest tax shield 410 Liquidation and reorganisation 421
Conclusion 411 Financial management and the bankruptcy process 422
Agreements to avoid bankruptcy 422
13.5 Bankruptcy costs 412 Summary and conclusions 422
Direct bankruptcy costs 412 Chapter review and self-test problems 423
Indirect bankruptcy costs 413 Critical thinking and concepts review 424
13.6 Optimal capital structure 413
The static theory of capital structure 414
Mini-case: Stephenson Real Estate recapitalisation 428
CHAPTER 14 DIVIDENDS AND DIVIDEND POLICY 430
14.1 Cash dividends and dividend payment 431 Share repurchase and EPS 442
Cash dividends 432
14.4 What we know and do not know about
Standard method of cash dividend payment 432
dividend and payout policies 443
Dividend payment: a chronology 432
Corporations smooth dividends 443
More on the ex-dividend date 433
Putting it all together 443
14.2 Does dividend policy matter? 434 Some survey evidence on dividends 445
An illustration of the irrelevance of dividend policy 435
14.5 Bonus issues and share splits 446
A test 435
Value of share splits and bonus issues 447
Some real-world factors favouring a low payout 436
Reverse splits 447
Some real-world factors favouring a high payout 437
Clientele effects: a resolution of real-world factors? 439
14.3 Share repurchase: an alternative to Critical thinking and concepts review 449
cash dividends 439 Questions and problems 450
Cash dividends versus repurchase 440 What’s on the web? 452
Real-world considerations in a repurchase 441 Mini-case: Electronic Timing Ltd 453
Finance matters: Share buybacks: no end in sight 442
CHAPTER 15 RAISING CAPITAL 454
15.1 The financing life cycle of a firm: 15.5 IPOs and underpricing 461
early-stage financing and venture capital 455 Evidence on underpricing 461
Venture capital 455 Why does underpricing exist? 463
Some venture capital realities 456 Finance matters: IPO underpricing around the world 464
Choosing a venture capitalist 456
15.6 New equity sales and the value of the firm 465
Conclusion 457
15.7 The cost of issuing securities 466
15.2 Selling securities to the public:
Finance matters: Anatomy of an IPO 467
the basic procedure 457
15.8 Issuing long-term debt 468
15.3 Initial public offering, rights issues
and private placements 458
Chapter review and self-test problem 469
15.4 Underwriters 459 Critical thinking and concepts review 469
Choosing an underwriter 459 Questions and problems 472
Types of underwriting 459 What’s on the web? 472
Underwriting fees 460 Mini-case: Kiwi Yachts goes public 473
CONTENTS xi
PART EIGHT SHORT-TERM FINANCIAL MANAGEMENT

CHAPTER 16 SHORT-TERM FINANCIAL PLANNING 476
16.1 Tracing cash and net working capital 477 Cash outflows 491
The cash balance 492
16.2 The operating cycle and the cash cycle 479
Defining the operating and cash cycles 479 16.5 Short-term borrowing 493
The operating cycle and the firm’s organisational chart 480 Unsecured loans 493
Calculating the operating and cash cycles 481 Secured loans 494
Interpreting the cash cycle 483 Other sources 495
Finance matters: Cash cycle competition 484
16.6 A short-term financial plan 495
16.3 Some aspects of short-term financial policy 485 Summary and conclusions 497
The size of the firm’s investment in current assets 485 Chapter review and self-test problems 497
Alternative financing policies for current assets 486 Critical thinking and concepts review 499
Which financing policy is best? 488 Questions and problems 500
Current assets and liabilities in practice 489 What’s on the web? 504
Mini-case: Jumbuck Manufacturing working-capital
16.4 The cash budget 490
management, part 1 505
Sales and cash collections 490
CHAPTER 17 WORKING CAPITAL MANAGEMENT 508
17.1 Cash and liquidity management 509 17.5 Inventory management techniques 522
Reasons for holding cash or cash-like assets 509 The ABC approach 522
The economic order quantity model 522
17.2 Cash management: collection,
Extensions to the EOQ model 526
disbursement and investment 510
Finance matters: Supply chain management 529
Cash collection 510
Managing cash disbursements 511
Chapter review and self-test problem 530
Investing idle cash 512
17.3 Credit and receivables 514 Questions and problems 532
Components of credit policy 514 What’s on the web? 533
Terms of the sale 514 Mini-case: Jumbuck Manufacturing–working
Optimal credit policy 517 capital management, part 2 534
Credit analysis 518
Collection policy 519
17.4 Inventory management 521
The financial manager and inventory policy 521
Inventory types 521
Inventory costs 521
xii CONTENTS
PART NINE TOPICS IN BUSINESS FINANCE

CHAPTER 18 INTERNATIONAL ASPECTS OF FINANCIAL MANAGEMENT 536
18.1 Terminology 537 18.5 Exchange-rate risk 550

Short-run exposure 550
18.2 Foreign exchange markets and exchange rates 538
Long-run exposure 551
Exchange rates 538
Translation exposure 551
Types of transactions 543
Managing exchange-rate risk 552
18.3 Purchasing-power parity 544
18.6 Political risk 552
Absolute purchasing-power parity 544
Finance matters: McPricing 546
Relative purchasing-power parity 546
18.4 Exchange rates and interest rates 548 Questions and problems 556
Covered interest arbitrage 548 What’s on the web? 558
Interest rate parity 549 Mini-case: Kiwi Yachts goes international 559
Appendix A 561
Appendix B 570
Glossary 574
Index 580
CONTENTS xiii
ACKNOWLEDGMENTS
WE ARE INDEBTED to our academic colleagues at the University of Technology Sydney and other institutions
in Australia and New Zealand who contributed to the development of this adaptation through their thoughtful reviews,
including:
• Peter Phillips, University of Southern Queensland
• Mark Werman, Massey University
• Norah Ellery, University of Otago
and for their work on the previous edition:
• John Ablett, University of Western Sydney
• Zhian Chen, University of New South Wales
• Philip Cheng, Australian National University
• Deborah Cotton, University of Technology Sydney
• Grant Cullen, Murdoch University
• Bill Dimovski, Deakin University
• Norton Grey, University of Tasmania
• Rakesh Gupta, Central Queensland University
• Ben Jacobsen, James Cook University
• Buly Cardak, La Trobe University
• Jenny Kofoed, Central Queensland University
• Kirsten MacDonald, Lincoln University
• Sian Owen, University of New South Wales
• Toan Pham, University of New South Wales
• Mike Poë, University of Technology Sydney
• Tony Stanger, Flinders University
• Max Tani, University of New South Wales
• Tony van Eekelen, Deakin University
• Scott Walker, University of Technology Sydney.
We are grateful to Walid K. Bakry, Alexandria University, for his contributions to this third edition, including providing a large
number of the opening chapter stories and Finance Matters segments, and the completion of the Solutions Manual for the
end-of-chapter questions.
The publication of a work such as this would not be possible without the enthusiasm of the team at McGraw-Hill.
We thank our publisher, Jillian Gibbs, for her unfailing support and enthusiasm—words cannot express our gratitude! We
also thank our development editor, Katy McDevitt, for her dedication to the project and willingness to ‘walk on water’ to
help us meet deadlines; design coordinator, Dominic Giustarini, for organising our eye-catching cover and vibrant internal
design; copy editor, Owen Kavanagh, and senior production editor, Yani Silvana, for their incredible professionalism and
attention to detail; digital resources team including digital content developer, Belinda Lum, and digital production manager,
Marisa Rey Bulen, who carefully managed the integration of Connect for this edition. We thank the marketing manager
for business and economics, Natasha Oostergetel, for her enthusiasm in promoting the book internally and externally,
and in guiding our promotional material. We sincerely thank these people for all their hard work. A special thanks to
Rory Manchee at Standard & Poor’s, Melbourne, for graciously providing us with access to essential financial data for
this edition.
xiv
PREFACE
INTRODUCTORY FINANCE courses have changed over the years, and the number of prerequisite subjects
has been reduced to the point that a large number of students are studying finance with little or no business background
or knowledge of accounting and/or economics. In addition, many of these students will not undertake any further finance
courses. As a consequence, these courses need a special type of finance text—one that provides students with a broad
coverage of the essential topics in a way that allows for their minimal preparation, while still providing an introduction for
the intended finance majors.
A review of the burgeoning number of finance texts that have been prepared for the Australian and New Zealand
markets confirmed our expectations that a satisfactory text did not exist in the local market to meet the special needs of
these introductory finance courses. However, Ross, Westerfield and Jordan’s Essentials of Corporate Finance, a successful
American textbook which has been developed through eight editions, stood out for this particular segment. A key to its
success is the use of stories based on real-world experiences, rather than a description of the theory, to develop the
important finance concepts. In addition, its chatty writing style is much appreciated by students, particularly those with little
preparation and/or those for whom English is a second language.
However, this textbook did not provide an ideal solution for those teaching or studying an introductory finance
course in Australia and New Zealand. While a large amount of finance theory is generic, the institutional environment and
terminology used across countries is not. The solution was apparent: a local adaptation of the text, while being careful not
to depart from its winning ways.
The fruits of our labour are to be found in this text, which maintains the well-recognised Ross et al. formula, while using
local terminology and explaining everything within an Australian and New Zealand setting. The Ross tradition of using real-
world examples of either Australian or well-recognised international companies has also been incorporated. The subject
of finance is distilled down to its bare ‘essentials’ while retaining a modern approach.
The book is arranged in nine parts to enable a flexible approach to the subject material, allowing subject coordinators
to decide the particular sequence. Each chapter begins with an overview of the chapter’s content and concludes with
material that is an extension of the earlier material. In the event of insufficient time, the latter may be omitted without
affecting a basic coverage of the essential material. At the end of each chapter is a large selection of practical and theoretical
problems of varying degrees of difficulty for students to solve. In addition, each major section concludes with a mini-case
that introduces a practical application of the material covered.
Perhaps the most challenging aspect of writing this adaptation has been the incorporation of the Australian and the
New Zealand imputation tax system. As the theoretical development of finance has largely been undertaken within the
framework of a classical tax system, we chose to commence our discussion within this environment and then extend the
discussion to incorporate an imputation tax system. Our approach to imputation has been to treat it at a basic level and
not overly complicate the issue for students.
We feel that we have successfully achieved our goal of producing a text that conveys the most important concepts
and principles of finance at a level that is approachable for the widest possible audience in a package that realistically can
be covered in a single term.
Rowan Trayler
Ron Bird
xv
ABOUT THE ORIGINAL AUTHORS
Stephen A. Ross is the Franco Modigliani Professor of

Finance and Economics at the Sloan
School of Management, Massachusetts Institute of Technology. One of the most widely
published authors in finance and economics, Professor Ross is recognised for his work in
developing Arbitrage Pricing Theory and his substantial contributions to the discipline through
his research in signalling, agency theory, option pricing and the theory of the term structure of
interest rates, among other topics. A past president of the American Finance Association, he
currently serves as an associate editor of several academic and practitioner journals. He is a
trustee of CalTech and a co-author of Fundamentals of Corporate Finance 9e (US edition) and
Corporate Finance 9e (US edition), both published by McGraw-Hill/Irwin.
Randolph W. Westerfield is Dean

Emeritus
of the University of Southern California’s Marshall School of Business and is the Charles B.
Thornton Professor of Finance. He came to USC from the Wharton School, University of
Pennsylvania, where he was the chairman of the finance department and a member of the
finance faculty for 20 years. He is a member of several public company boards of directors
including Health Management Associates, Inc. and the Nicholas Applegate Growth Fund.
His areas of expertise include corporate financial policy, investment management and stock
market price behaviour. He is a co-author of Fundamentals of Corporate Finance 9e (US
edition) and Corporate Finance 9e (US edition), both published by McGraw-Hill/Irwin.
Bradford D. Jordan is Professor of Finance and

holder of the Richard W.
and Janis H. Furst Endowed Chair in Finance at the University of Kentucky. He has a long-
standing interest in both applied and theoretical issues in corporate finance and has extensive
experience teaching all levels of corporate finance and financial management policy. Professor
Jordan has published numerous articles on issues such as cost of capital, capital structure and
behaviour of security prices. He is a past president of the Southern Finance Association and
he is a co-author of Fundamentals of Investments: Valuation and Management 5e, a leading
investments text, also published by McGraw-Hill/Irwin.
xvi
ABOUT THE AUSTRALIAN AUTHORS
Rowan Trayler is a Senior Lecturer in the Business School at

the University of Technology Sydney (UTS)
and has held a number of administrative appointments, including Director of the Bachelor of
Business and Director of the Master of Business in Finance. He has taught introductory finance
courses to both undergraduate and postgraduate students at UTS for more than 25 years.
His experience includes teaching small groups and executive MBA classes, and giving mass
lectures for first year undergraduate finance students. He has also been a visiting lecturer at
several universities in the United States and has conducted a number of in-house finance
courses for non-finance executives.
Rowan has extensive experience in the banking and finance industry and has several
international publications to his name in these areas. He was a member of the New
South Wales state committee of the Australasian Institute of Banking and Finance from
2000 to 2005.
His teaching philosophy is closely aligned to the writing style of the Ross text and this
Australian adaptation incorporates that style. Rowan has a straightforward and well-designed
approach to teaching introductory finance courses, which students appreciate, and he is keen
to embrace new technologies in teaching, including web-based resources.
Ron Bird began his academic career at Macquarie University in 1970,

before moving to the Economics Faculty at the Australian
National University (ANU) in Canberra in 1973, where he became a Professor in, and Head
of, the Commerce Department.
After leaving the ANU in 1988 (and subsequently being awarded the title of Emeritus
Professor by that university), Ron embarked on a career in the private sector, including asset
consulting with Towers Perrin and funds management with Westpac, before establishing a
new funds management firm in conjunction with Grantham, Mayo, Van Otterloo (Boston).
Ron returned to academia in 1999, joining the University of Technology Sydney, where he is
now Director of the Paul Woolley Centre for Capital Market Dysfunctionality.
Ron was co-author of the first corporate finance text to be published in Australia and has
authored copious articles in Australian and international journals. He has also made numerous
conference presentations and held visiting positions at several prestigious American, British
and European universities. Ron maintains interests outside of the university and has been the
academic adviser to several asset management firms and has undertaken consulting projects
for the financial services sector more generally.
His current research interests are directed towards arriving at a better understanding
of the economic and social costs attributable to dysfunctional capital markets and financial
institutions and the associated policy implications.
xvii
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NOTE.
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TO OUR CUSTOMERS.
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CRANE & ALLEN.
Index to Letters.
PAGE.
Abbott, J. L., Northfield, Vt., 68
Albaugh & Lanum, Circleville, O., 62
Albright, J. W., E. Liverpool, O., 61
Allen, Henry & Son, Norwich, Conn., 112
Allington, J. W., Webster City, Ia., 60
Anderson, S., Traverse City, Mich., 112
Andrews, R. T., Thomaston, Conn., 65
Applegate, J. L., Anna, O., 114
Argabrite, S. L., New Carlisle, Ind., 127
Ashley, H. J, Torrington, Conn., 135
Atkinson Bros., Pecatonica, Ill., 82
Augustine, S. G. & Son, Racine, Wis., 120
Bacon, C., Baraboo, Wis., 76
Bailey, M. H. & Co., Chillicothe, Ill., 82
Bainbridge & Hause, Clinton, Mich., 99
Baker, S. S., Chebanse, Ill., 63
Baker & Yard, Utica, Pa., 111
Baldwin, T. A., Fowler, Ind., 111
Barmore, D. R., Spirit Lake, Iowa, 99
Barnard & Radley, Earlville, Ill., 111
Barnes, James, Grand Haven, Mich., 74
Barrett, D., New Martinsburg, O., 74
Bartle, F. C., Dodgeville, Wis., 129
Bassett, E. F., Seymour, Conn., 80
Bauder, S. E., Birmingham, O., 83
Bauer, Wm., Weyauwega, Wis., 91
Baxter, D. A., Rochelle, Ill., 85
Beard, T. & Co., Hudson, Wis., 63
Beatty & Brown, Cascade, Ia., 112
Bechstein, Chas. & Co., Mancelona, Mich., 81
Beebe, C. B., Beaver Dam, Wis., 95
Beebe, L. H., Pinckney, Mich., 111
Beelman, John, Plymouth, O., 104
Beiderwolf, M., Monticello, 103
Belden, J. T., Marengo, Ill., 69
Benedict, Chas. A., New York City, 106
Berk, Fry & Co., Dayton, O., 111
Bird, H. T., Mt. Pleasant, Ia., 114
Bishop, A. F., Mineral Point, Wis., 74
Black, J. S., Bainbridge, Ind., 106
Blue, W. C. & Son, Gallatin, Tenn., 114
Bone, D. M. & Co., Petersburg, Ill., 91
Booth, J. I. & Son, Groton, N. Y., 64
Borst, Josiah, Cobleskill, N. Y., 109
Bowden, L. S. & Son, Brookfield, Mo., 109
Bowers, J. S., Waterloo, Ind., 99
Bradrick & Son, Chariton, Ia., 99
Bragunier & Cox, Delphi, Ind., 109
Brewster & Co., Middlebury, Vt., 56
Bringhurst, R. R. & Co., Philadelphia, 96
Bucher, H., Lisbon, Ia., 65
Buckhart, J. & Son, Sandwich, Ill., 54
Bullard, J. B., Decatur, Ill., 132
Bullock, G. W., Burr Oak, Mich., 85
Buren, A. B., Jamesport, Mo., 64
Burket Bros., Creston, Ia., 91
Burpee, N. A. & S. H., Rockland, Maine, 132
Camp, J. H., Bement, Ill., 131
Canfield, J. H., Harrison, Mich., 134
Casebolt, S., Ashland, Ky., 123
Catlett, E., Woodbury, N. J., 129
Chaffee, F., Chicago, 71
Chamberlin, R., Republic, O., 83
Chamberlin, S. S. & Son, Joliet, Ill., 60
Chandler, W. M., Salem, Mass., 72
Chase & Churchill, Weeping Water, Neb., 123
Cheney, J. E., Mondovi, Wis., 112
Churchill, G. W. & Son, Eaton, O., 72
Clark Bros., Kalkaska, Mich., 105
Clarke, W. H., Edgerton, Wis., 60
Clausen, P., Albert Lea, Minn., 90
Clawson & Hawks, New York City, 116
Clement, A. T., Clarinda, Ia., 82
Cochonour, M. G., Casey, Ill., 89
Cohee & Spaugh, Hope, Ind., 54
Comley & Bird, Frankfort, Ind., 61
Compton, C. W., Newark, N. J., 122
Conn, G. B., Greensburg, Pa., 96
Conover, J. H., Van Wert, O., 131
Corell, W. J. & Co., Bloomsburg, Pa., 83
Cornelius, F., Darlington, Wis., 131
Cottingham, S. D. & Co., Noblesville, Ind., 121
Couts, Jno. F., Clarksville, Tenn., 84
Cowan, J. S., Delphos, O., 89
Cox & Reed, Hastings, Neb., 81
Crandell, S. C., Westfield, N. Y., 57
Crawford, A., North Bend, Neb., 127
Crawford, Wm., Franklin Grove, Ill., 120
Cree, R. S., Nunda, N. Y., 89
Cring, John, Portland, Ind., 130
Cropper, E. S., Zionsville, Ind., 89
Crowell, J. & Co., Summitville, Ind., 116
Crowley, J. & Son, Hamilton, O., 60
Crumbie, Thos. J., Chester, Pa., 90
Culp, George, Nokomis, Ill., 124
Dain, John F., Oswego, N. Y., 126
Damon, W. F., Kenton, O., 115
Danahy, T. J., Lexington, Ky., 69
Danforth, C. W., Ovid, Mich., 121
Darrin, J. W., Corning, N. Y., 77, 138
Davey, B. T., Dodgeville, Wis., 136
Davidson, Wm., Titusville, Pa., 119
Davis Bros., Morris, Ill., 67
Davis, J. M., Alma, Neb., 78
Davis, W. W., Arcade, N. Y., 102
Davis & Hover, Ada, O., 86
Deckman, Geo., Malvern, O., 67
Delano & Cooley, Ripon, Wis., 56
Demple, Geo. A., Bonaparte, Ia., 67
Dexter, E., Danielsonville, Conn., 122
Diggins, Geo. E., Marengo, Ill., 52
Dillman, A. C., Bryan, O., 69
Dinning, E., McKenzie, Tenn., 56
Disbrow, Benj. L., Trenton, N. J., 55
Dolph & Ickes, Elmore, O., 134
Donaghy & Howe, Hillsdale, Mich., 116
Donnelly, Chas. & Co., Covington, Ky., 69
Drake, W. H., Morrisonville, Ill., 128
Drescher, F. E., Greensburg, Kan., 120
Dunklee & Easterly, Anamosa, Ia., 70
Dunlap & McGoodwin, Danville, Ky., 79
Dunlay, W. J. & Co., New Britain, Conn., 120
Dunn, L. D., Meadville, Pa., 78
Early, E. S. & Son, Philadelphia, 106
Edgcomb & Ballard, Cortland, N. Y., 49
Edwards & Corlett, Newton, Kan., 49
Eiker & King, Fort Dodge, Ia., 128
Eldred, H., Gardner, Ill., 86
England, Barr & Co., Lebanon, Ky., 86
Ervin, S. J., Parker City, Pa., 128
Fay, H. W., Marlboro, Mass., 94
Fedde, Henry & Son, Peotone, Ill., 102
Feiten, John, Mishawaka, Ind., 94
Feith, N., Cairo, Ill., 58
Fernald & Co., Austin, Minn., 58
Field, L. & Co., Clinton, Mass., 50
Fies, William, Marion, O., 120
Fillmen, Jas. M., Pottstown, Pa., 58
Fisher., A. C., Concord, N. H., 118
Fletcher, R. B., Cortland, N. Y., 58
Fowler, O. S., Maynard, Mass., 134
Francis, J. B., Canandaigua, N. Y., 120
Frantz, D. A., Lebanon, Pa., 102
Frear, J. S., Binghamton, N. Y., 67
Frink, Daniel, Watertown, N. Y., 94
Frost, E. N. & Son, Athens, Pa., 94
Gable, W. H., Hartford City, 133
Gamble, L. D., Perry, Ia., 97
Gardner, W. P., Gilman, Ill., 54
Gaspar, Chas., Waukesha, Wis., 115
Gehres, A., Waverly, O., 100
Gentry, J. M., Louisiana, Mo., 77
Gerstle, F. W. & Son, Cincinnati, 76
Gibson & Beck, Fairfield, Ia., 101
Giering & Martin, Emlenton, Pa., 114
Gilmore, J., Gridley, Ill., 101
Goodrich, H., Howell, Mich., 133
Goodwin, Samuel, St. Thomas, Ont., 76
Gray, A. M., Hampton, Ia., 116
Greene, W. Harvey, Rochester, Mich., 75
Greenlund, N., Warren, Pa., 55
Greenlund, P., „„ 116
Gustin, E. & L., Denver, 71
Haas & Wassom, Peru, Ill., 128
Hackenburger, J., Grand Rapids, O., 114
Hackman, H., Staunton, Ill., 83
Hackman, N. H. & Co., Cincinnati, 73
Haines, A., Middlebury, Ind., 135
Hall, E. T., Titusville, Pa., 131
Holst, J. F. & Bro., Memphis, Tenn., 75
Hancock, C. H., Seymour, Ind., 137
Hansen & Huck, Kenosha, Wis., 78
Hardy, H. W., Lincoln, Neb., 97
Hargrave Bros., Rockville, Ind., 78
Harrouff, J. A., Atchison, Kans., 77
Hawley & Sayer, Danbury, Conn., 73
Henry, G. S., Avilla, Ind., 133
Herriff & Reed, Kent, O., 125
Hershey Bros., Gettysburg, O., 78
Hess & Houston, Virden, Ill., 135
Hildabolt, H., Germantown, O., 84
Hinton, T. J., Flemingsburg, Ky., 73
Hiss, Sebastian, Plainfield, Ind., 59
Hodge Bros., Paris, Ill., 134
Hoeft & Tucker, Berlin, Wis., 124
Holaday, D., Ottawa, Kans., 133
Hole, R. & W. M., Salem, O., 70
Holmes & Co., Saratoga Springs, N. Y., 127
Horn, C. W., Tiffin, O., 128
Hosmer, M. W., Burlington, Vt., 79
Houston, J. E., Beloit, Wis., 84
Howard, M. D., Jordan, N. Y., 85
Howard & Dinsmore, Carlisle, Ky., 84
Howland, H. F., Streator, Ill., 63
Hoy, A. L., DuBois, Pa., 65
Hudson & Tippett, Shawnee, O., 79
Hunn, F. S., Omaha, Neb., 133
Hunt, J. J., Peoria, Ill., 117
Hurlburt, Geo. R., Dansville, N. Y., 63
Jacoby & Ryerson, Wilton Junction, Ia., 77
James, J. P. & Co., Greenfield, Ind., 70
Janesville Furn. Co., Janesville, Wis., 65
Jardine & Hance, Succasunna, N. J., 123
Johnson, W. S., Carthage, 124
Jones, Rob’t H., Memphis, Tenn., 75
Kahler, C., New Washington, O., 139
Kampp, Conrad, Wheaton, Ill., 67
Karstens, C. N., Nebraska City, Neb., 52
Kaufman & Hoefs, Newton, Kans., 103
Keesling, C. B., Pendleton, Ind., 126
Kenney & Dillon, Hartford, Conn., 68
Kepner, J. P., Cicero, Ind., 136
Kilian & Williams Furn. Co., Salina, Kan., 109
King, E. L., Corry, Pa., 115
Knox, C. B., Rock Island, Ill., 125
Kolb, F., Reinbeck, Ia., 136
Kranbuehl, J. T., Dysart, Ia., 138
Kremer & Oplinger, Wadsworth, O., 66
Labbitt, Henry, Galesburg, Mich., 61
Laird, James A., Weedsport, N. Y., 137
Lake City Furn. Co., Lake City, Minn., 52
Lake, John, Baltimore, Md., 61
Lambson, C. K., Westfield, Mass., 135
Landis, D. Y., Wooster, O., 66
Landis, E. S., Coatesville, Pa., 51
Lash, N. G., Montpelier, 59
Latimer & Hamilton, Detroit, 124
Lawler, J. A., Eau Claire, Wis., 62
Lawrence, A. B., Warsaw, N. Y., 51
Lenhart, John S., Peru, Ind., 139
Leslie, Wm., Rich Hill, Mo., 136
Lindsay & Wackman, Oregon, Wis., 57
Lindsey, Jno. & Son, Mt. Sterling, Ky., 59
Lloyd, John, Worcester, Mass., 66
Logan, D. L., Moundsville, W. Va., 58
Long, F. M., West Chester, O., 56
Long, Geo. J., Coal Centre, Pa., 62
Luger Furn. Co., Fargo, Dak., 59
Luke, Robert, Wheeling, W. Va., 66
Lyke, H. F., Oconomowoc, Wis., 89
Lyon, Geo. C., Fair Haven, 66
Lyon, John W., New York City, 126
Lyons, J. L., Greenfield, Mass., 53
McCormick, J. & Son, Mt. Vernon, O., 68
McCurdy, J. B., Oskaloosa, Ia., 64
McDermott, J. H., Lowell, Mass., 50
McDonnell, A., New Hampton, Ia., 73
McKean, W., Forest, O., 138
McKee, A. A., McLean, N. Y., 50
McKinstry, Jno. & Son, Beaver Dam, Wis., 137
Manville, Geo. E., Willoughby, O., 80
Marsh, H. E., Rockford, Ill., 50
Marshman, H. H. & Co., Jackson, O., 139
Martin, Thos., Palmyra, Mo., 138
Mason Bros., Frankfort, Kans., 136
Matthews, A. A., Erie, 139
Matthews, N. C., Winchenden, Mass., 74
Means & Leach, Quincy, O., 73
Meister, Oscar, Chicago, 53
Merrill, E. G., Anthony, Kans., 137
Merritt, Stephen, New York City, 49
Meyners, E., Highland Park, Ill., 112
Miller, E. S., Reading, Pa., 53
Miller, Jacob, West Milton, O., 57
Miller, J. H., Edgerton, O., 93
Miller, M. H., Tipton, Ia., 139
Misener, Jacob, N. Manchester, Ind., 137
Mitchell, N. B., Oconto, Wis., 81
Mitchell & Beck, Wilmington, Del., 94
Mohlman, W. F., Beardstown, Ill., 104
Muller & Cockburn, Stillwater, Minn., 136
Murrell, Jos. P., St. Louis, 50
Murray, B. E., Boston, 93
Myall & Riley, Maysville, Ky., 96
Nelson, C. C., Cassopolis, Mich., 87
Noel & Arthur, Altoona, Pa., 96
North, M. D., Vassar, Mich., 140
Oakes, J. T. & Co., Pulaski, Tenn., 88
Oblander Bros., Bushnell, Ill., 92
Ocheltree, J. R., Homer, Ill., 140
Ogden, J. H., Massillon, O., 91
Olinger, J. W., Santa Fe, N. M., 85
Osborn, G. & Sons, Michaelsville, Md., 87
Partridge & VanDusen, Jamestown, N. Y., 62
Patterson, A. & J. W., Braidwood, Ill., 71
Patterson, J. H., River Falls, Wis., 140
Paul, Geo. Chandler, Philadelphia, 70
Payne & Payne, Broadhead, Wis., 104
Payne, E. W., Villisca, Ia., 139
Pease & Bright, Wakeman, O., 83
Perry, Chas. L., Boston, 52
Phillips, T. D., Menasha, Wis., 110
Phlipson, Jno., Fox Lake, Wis., 92
Pierce, E. C., Blair, Neb., 91

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Copyright © 2014 McGraw-Hill Education (Australia) Pty Ltd

National Library of Australia Cataloguing-in-Publication Data

PART 1 OVERVIEW OF FINANCIAL MANAGEMENT 1

PART 2 UNDERSTANDING FINANCIAL STATEMENTS AND CASH FLOW 23

PART 3 VALUATION OF FUTURE CASH FLOWS 93

PART 4 VALUING SHARES AND BONDS 157

PART 5 CAPITAL BUDGETING 227

PART 6 RISK AND RETURN 295

PART 7 LONG-TERM FINANCING 369

PART 8 SHORT-TERM FINANCIAL MANAGEMENT 475

PART 9 TOPICS IN BUSINESS FINANCE 535

PART ONE OVERVIEW OF FINANCIAL MANAGEMENT

1.1 Finance: a quick look 3 Finance matters: Corporate ethics 11

PART TWO UNDERSTANDING FINANCIAL STATEMENTS AND CASH FLOW

CHAPTER 3 WORKING WITH FINANCIAL STATEMENTS 52

3.1 Standardised financial statements 53 ROA, ROE and growth 70

PART THREE VALUATION OF FUTURE CASH FLOWS

CHAPTER 5 DISCOUNTED CASH FLOW VALUATION 118

PART FOUR VALUING SHARES AND BONDS

CHAPTER 7 EQUITY MARKETS AND SHARE VALUATION 202

PART FIVE CAPITAL BUDGETING

CHAPTER 9 MAKING CAPITAL INVESTMENT DECISIONS 262

PART SIX RISK AND RETURN

10.1 Returns 297 Using capital market history 315

CHAPTER 11 RISK AND RETURN 332

PART SEVEN LONG-TERM FINANCING

CHAPTER 13 LEVERAGE AND CAPITAL STRUCTURE 398

CHAPTER 14 DIVIDENDS AND DIVIDEND POLICY 430

CHAPTER 15 RAISING CAPITAL 454

PART EIGHT SHORT-TERM FINANCIAL MANAGEMENT

CHAPTER 17 WORKING CAPITAL MANAGEMENT 508

PART NINE TOPICS IN BUSINESS FINANCE

18.1 Terminology 537 18.5 Exchange-rate risk 550

ABOUT THE ORIGINAL AUTHORS

Stephen A. Ross is the Franco Modigliani Professor of

Randolph W. Westerfield is Dean

Bradford D. Jordan is Professor of Finance and

ABOUT THE AUSTRALIAN AUTHORS

Rowan Trayler is a Senior Lecturer in the Business School at

Ron Bird began his academic career at Macquarie University in 1970,

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To see how you can access these

Howell, Mich., Aug. 7, 1886.

We use your Preservative in preference to anything else of the

Hartford City, April 5, 1887.

Omaha, Neb., June 10, 1884.

Avilla, Ind., April 21, 1886.

Titusville, Penn., Oct. 9, 1884.

Maynard, Mass., Sept. 22, 1885.