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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

• Mini Case 195
6 The Meaning and Measurement of Risk

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

• Mini Case 234
7 The Valuation and Characteristics

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

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

• Mini Case 267
8 The Valuation and Characteristics

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

• Mini Case 293
9 The Cost of Capital 294

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

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

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

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

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

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

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

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

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

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

• Mini Cases 442
13 Dividend Policy and Internal Financing 444

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

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

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

Business Finance 466
14 Short-Term Financial Planning 466

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

• Mini Case 484
15 Working-Capital Management 486

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

Secured Sources: Inventory Loans 505
16 International Business Finance 514

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

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

Web Appendix A Using a Calculator

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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“Sure, when you cut in on the switchboard. I have to keep listening,
to tell when they’re finished, ’cause there’s most always somebody
waitin’ for our wire.”
“So you think Sandow is trying to get part of the old doctor’s
money?” asked Tom.
“That’s my idea,” replied Charley. “I guess it wouldn’t be so hard,
either, for the doctor’s so forgetful he might have a hundred or five
hundred dollars one minute, and not find it the next, and he wouldn’t
know what become of it.”
There came at once to Tom’s mind the scene he had witnessed that
evening in the doctor’s home—the confusion about the money, and
the puzzled air of the physician—when he could not find it in his
wallet.
“Well, this is my street,” announced Charley, as he paused on a
corner. “Come on over some night and see a fellow.”
“I will, only I can’t until after the holidays. We’re going to keep open
evenings beginning next week.”
“That’s tough. You ought to be a telephone boy, and get done at
three o’clock. I went to a moving picture show this afternoon.”
“I wish I could go. But let me know if you hear of a chance for me,
Charley.”
“I will, Tom. Hope you keep your job.”
“I don’t know as I want to, since I’ve heard about yours,” replied Tom
with a laugh. “Good-night.”
Tom hurried on to his home. As he reached the steps, and felt for the
key of the door, he gave a sudden start. The envelope containing the
ten dollars which Dr. Spidderkins had given him, and which he had
put in his pocket, was gone!
CHAPTER VI
OUT OF WORK
Thinking he might not have looked in the right pocket, Tom made a
hasty search through all the others.
“No use,” he said dolefully, “it’s gone! I must have dropped it after I
left the house. What’s to be done?”
The situation was serious for the lad. He wished he had been more
careful, but he had been so engaged in thinking of the queer actions
of Mr. and Mrs. Sandow, and in talking to Charley Grove, that he had
given little thought to the money.
“Mr. Townsend will think I have stolen it, when I go to him in the
morning, and say I’ve lost it,” murmured Tom. “I wish I had been
more particular. Maybe there was a hole in my pocket.”
He looked, but there was none, for Mrs. Baldwin attended carefully
to her son’s clothes.
“This is certainly a pickle!” exclaimed the boy to himself softly. “I
wonder what I’d better do? Maybe if I go back the way I came I’ll find
the envelope lying in the street. It was a good-sized, white one, and I
can easily see it.”
“But maybe I dropped it in the car,” he added. “No, I don’t believe I
could have done that, or some of the passengers or the conductor
would have seen it on the floor, and told me about it. I must have lost
it either before I got on the car, or afterward. I’ll walk back to where I
met Charley, and see if it’s there.”
It was nearly eleven o’clock now, and as Tom looked up at the silent
little house, where his mother and aunt were doubtless sleeping, he
wondered if he had better go in and tell his parent about the loss,
and inform her that he was going to look for the money.
“No, I’ll not do that,” he decided. “She’ll only worry about it, and she
has troubles enough. I’ll hurry as much as I can, and get back as
soon as possible. Still, if I’m not in by midnight she may worry too.
But then I told her I was likely to be late any night now, for I might
have to deliver books in the suburbs. I guess she won’t worry if I
don’t go in right away.”
Deciding that this was the best plan, Tom descended the steps of his
home, and hurried back over the route he had taken from the car.
How eagerly he scanned the pavement, looking for that white,
square envelope! Every scrap of paper he saw made his heart flutter,
until he came close to it, and saw that it was not what he sought.
“Well, here’s where I took the car,” he said, as he reached the corner
where he had alighted. “Either I didn’t drop it along this way, or if I
did, some one has picked it up. Now for the second part of my
search.”
He waited for a car to come along, to take him back to Dr.
Spidderkins’ house, and it was a cold, lonesome wait for Tom, who
felt quite miserable over what had happened. To his delight he saw
on the car the same conductor with whom he had ridden about an
hour before. The man was on the return trip.
“Did you find an envelope in the car, after I left?” asked Tom eagerly,
as he got aboard, and told the circumstances.
“Didn’t find anything but an old lunch box, and there was nothing in
it,” said the conductor.
“Then I must have dropped it before I got on the car,” decided Tom.
Arriving at the place where he had first boarded the electric vehicle,
he alighted and hurried over the ground toward the house of the
eccentric doctor. No sign of a white envelope greeted his anxious
eyes.
“I’m going to ask if it’s in the house,” the boy said to himself, as he
stood in front of the big, dark mansion. “I might have let it slip when I
thought I put it in my pocket, and perhaps they picked it up on the
floor. Though if Mr. and Mrs. Sandow did, they’re likely to keep it, if
what Charley Grove says is true.”
Tom rang the bell. It seemed like a quarter of an hour before some
one opened a window over his head and called:
“Well, what’s the matter? Is it a telegram?”
“I’m from Townsend’s book store,” replied Tom. “I came——”
“What! More books!” exclaimed a voice Tom recognized as Mrs.
Sandow’s. “You can’t leave ’em here to-night. Everybody’s to bed
long ago. You’ll have to come back in the morning.”
“I haven’t got any books,” said Tom. “I dropped the envelope with the
ten-dollar bill the doctor gave me, and I thought maybe it might be in
the house. Would you mind looking?”
“That’s a likely story!” sneered Mr. Sandow, joining his wife at the
window. “You probably stole that money, and now you want us to
help you lie about it. Clear out of here!”
“I didn’t steal the money!” exclaimed Tom. “I lost it! Will you please
look down in the sitting-room, or have Dr. Spidderkins do so?”
“The doctor’s asleep, and I’m not going to disturb him,” declared Mrs.
Sandow.
“I guess not!” added her husband. “Now clear out of here, and don’t
disturb us any more. You’re a nuisance, with your books and things!
I’ll put a stop to this buying of trash!”
“What’s the matter? What is it? Is it a burglar after my rare books?”
inquired Dr. Spidderkins, coming suddenly to the window, behind Mr.
and Mrs. Sandow. He leaned out, and Tom could see, in the light of
an electric arc lamp in front of the house, that the doctor was
dressed, and had on his spectacles, as if he had been sitting up
reading.
“Go back to bed!” called the woman.
“I haven’t been to bed. I must have forgotten to go,” answered the
doctor. “I was reading an account of how the Romans invaded
England. It’s in a very rare first edition of——”
The rest of the sentence was cut off, as Mr. Sandow slammed the
window down.
“They don’t want him to speak to me,” thought Tom. “I wonder what’s
the matter with that couple? They seem to want the doctor to do just
as they say.”
An instant later the window was raised again, and the aged
physician looked out.
“Did you say some one was stealing my books?” he asked. “Are you
a policeman? I’m much obliged to you. I hope the fellow didn’t get
my first folio Shakespeare.”
“No, I’m not a policeman! No books have been stolen!” cried Tom.
“I’m from Townsend’s book store.”
“Oh, yes. You’re Theopholus—no—I remember now; you’re Tom
Baldwin. Wait; I’ll be right down. Have you some more books for
me?”
Before the boy could answer, the window was shut again, but in less
than a minute the front door opened, and Dr. Spidderkins, holding a
candle in his hand, for he liked that old-fashioned method of going
about the house after dark, was inviting Tom to enter. The story of
the mishap was soon told.
“I thought maybe I might have dropped the envelope here,” the boy
finished.
“Wait a minute!” exclaimed Dr. Spidderkins, as he reached for his
pocketbook. He searched hurriedly through it. Then he uttered an
exclamation. “There! It’s all my fault. I knew I’d forget about it!”
“What?” asked Tom hopefully.
“Why, I gave you the wrong thing! There wasn’t any ten-dollar bill in
that envelope!”
“There wasn’t?” and Tom’s heart grew light again.
“Why, I gave you the wrong thing!” said Dr. Spidderkins.
Page 50.
“No. That envelope contained a list of books I wanted Mr. Townsend
to get for me. I meant to send it back to him by whoever called for
the ten dollars. I put the envelope in the compartment with the bill, so
I would remember about it. Then my memory played me a trick, and I
gave you the envelope with the list, and not the bill. So you haven’t
lost much of anything, after all. I can easily make out another list,
and here is the ten-dollar bill. Queer how that happened.”
“I guess it’s a good thing you didn’t give me the money,” said Tom
with a smile, “for I would have lost it. But I’ll be careful this time.”
He placed the bill in an inner pocket, and then, bidding the doctor
good-night, Tom once more started for home. This time he reached it
in safety, and he put the bill under his pillow when he went to bed.
He said nothing about the little adventure to his mother or aunt,
merely stating that he had been out late because of some business
for his employer. Nor did he mention the happening to Mr. Townsend.
The work at the book store became more exacting as Christmas
approached, and as customers increased, Tom was kept busy from
morning to night. He had to run on many errands, and he learned
more of Boston than he had ever known before.
He made many sales in the store, and several times he waited on Dr.
Spidderkins, but the physician made no reference to Tom’s midnight
visit. Probably he forgot all about it ten minutes after it occurred.
Christmas eve Tom was up until after midnight, delivering books to
late customers, and when he got back to the store about one o’clock
in the morning, he found Mr. Townsend about to close up.
“Tom,” said his employer, “you’ve done very good work for me, and I
assure you I appreciate it. We don’t open to-morrow, and here’s a
little remembrance for the Christmas season.”
He handed our hero a book of adventures that Tom had long desired
to possess.
“I am sorry,” went on Mr. Townsend, “that I won’t be able to keep you
after this week. You know I engaged you for the holiday rush, and
that’s over now, so I won’t need so many clerks. I am sorry to have
to let you go, as you suited me very well.”
“I’m sorry, too,” said Tom frankly, “but, of course, I understood when
you hired me that it was for the holiday season. I only hoped you
could keep me.”
“So did I, but I find I can not. Your week will not be up until Saturday,
but as there will be little to do, you need not come in that day, nor
Friday, though I will pay you for a full week. Here is the money. Now
if you want a reference, to get another position, call on me. I will be
glad to speak a good word for you.”
“Thank you, Mr. Townsend.”
“I think you can get work, somewhere,” went on the bookseller. “I
wish I could keep you, but I can’t. Times are too dull. Good-night,
Tom.”
Tom went home with a heavy heart, in spite of the fact that it was
Christmas morning, and that a book had been presented to him. He
was out of work, and he did not know where to look for a situation.
CHAPTER VII
LOOKING FOR A SITUATION
“Merry Christmas!” called Mrs. Baldwin, as she knocked on Tom’s

door that morning. “Merry Christmas, Tom!”
“Merry Christmas, mother!” he answered. He hurriedly dressed,
trying to keep up a cheerful spirit, but it was hard work. He went
downstairs, and handed to his mother and aunt each a pretty little
booklet, which he had purchased at the Emporium at reduced prices.
“Oh, Tom!” exclaimed his mother, “why didn’t you save your money?
I haven’t been able to get anything for you except some new socks.
You needed them very much.”
“Indeed I did, mother, and I couldn’t have anything better,” answered
the boy, giving his mother a hug and a kiss.
“Here is a pair of woolen gloves I knitted for you,” put in his aunt. “I’m
sure they’re not as nice as this Christmas book.”
“They’re a good deal more useful,” replied Tom. “Why, this is a pretty
good Christmas, after all, even if I have lost my job,” he said,
deciding this was a good time to break the unpleasant news.
“Lost your job, Tom!” exclaimed Mrs. Baldwin.
“Mercy sakes! Lost—your—job!” added his aunt.
“Well, I sort of expected it,” the youth answered ruefully, and he told
how it had come about.
“I rather hoped he might keep you on after the holidays,” remarked
Mrs. Baldwin.
“So did I,” said her son, “but, never mind, I’ll get a place somewhere.
Things are sure to be lively after the first of the year, and that’s only
a week off.”
“Oh, we’ll manage to get along, somehow,” declared Mrs. Baldwin
slowly. She did not want Tom to know how little money she had, nor
what a little sewing there was in prospect for her and her sister.
But in spite of these drawbacks it was quite a merry little Christmas
for Tom and his relatives, even though they had beef instead of
turkey, and no dessert at all.
Tom started off, early the next morning, to look for work, but he found
the Christmas spirit rather a detriment than otherwise, for many
places took advantage of the holidays and paid little attention to
business. The lad tramped the streets in vain, and came home that
night, tired and discouraged.
He awoke in the morning to find a foot of snow on the ground, and
more coming down.
“Here’s my work all cut out for me,” he said gleefully. “Mother’s socks
and Aunt Sallie’s gloves will just come in handy to-day. I’ll turn snow-
shoveler.”
After he had cleaned the sidewalk in front of his own house, he
shouldered the shovel and broom, and joined the army of men and
boys that had begun to gather to clear away the frozen crystals that
were still lazily floating down.
Whether the Christmas spirit induced householders to be more
liberal than usual, or whether Tom worked extra hard he did not stop
to consider, but the fact was he earned three dollars that day.
“This is better than working in a book store,” he said gleefully, as he
gave his mother a handful of change that night. “I’d like this regular, I
would.”
“But being in a book store is so educational and refining, Tom,”
remarked his aunt.
“Shoveling snow buys more bread and butter,” answered the matter-
of-fact boy with a laugh.
He resumed his search for work the next day, as there was no more
snow to shovel, but everywhere he applied he met with the reply that
there was nothing for him to do. All business seemed to have taken
a sudden drop after Christmas.
“It will be better after New Year’s,” decided Tom. “I’ll sure get a job
then.”
Anxiously he waited for January the second. He started off early that
morning, taking some lunch with him, as he found he could get
scarcely anything to eat in a restaurant for the money he could afford
to pay. He bought a paper, and turned to the column “Help Wanted.”
“Let’s see what firm offers boys the highest wages,” he said. “That’s
what I’m looking for.”
He saw several advertisements that seemed to offer a good chance,
but Tom was at this disadvantage—he had to walk to the places, for
he could not afford car fare. In this way he arrived too late in a
number of cases, the positions having been filled just before he
presented himself.
“I must pick out the places that are nearest by,” he decided, and he
went over the list again. He selected an advertisement of a firm on
Tremont Street, that wanted a boy to assist in packing. Tom found it
was a big crockery store.
“Have you had any experience in packing?” asked the manager, to
whom, after inquiring of several clerks, he was referred.
“We moved once, and I helped them,” said Tom, wondering what sort
of packing was done in the place.
“No, I’m afraid that would hardly do,” was the answer. “We want a
boy who has had experience in packing dishes.”
“I think I could learn,” spoke the boy eagerly.
“I’m afraid we couldn’t risk it. Our dishes are very valuable, and if a
boy broke one or two it would amount to more than his wages. We
require experienced help.”
“Couldn’t I learn by beginning to pack heavy dishes, that wouldn’t
break so easily, if I happened to drop one?” asked Tom.
“No, I’m afraid not.”
Tom wondered how a boy was ever going to get experience packing
fine dishes, if he never had any practice on heavy ones, but he did
not think it would do any good to ask the manager, so he left.
At the next place a boy was wanted to run errands, but as the wages
were only two dollars a week, Tom knew he could not afford to take
it, for he would hardly make his expenses. Then he saw an
advertisement of a boy wanted in a machine shop.
“That might do,” he mused. “I’m fond of machinery, and I often used
to go to the shop where father worked.”
“We want a boy to learn the trade,” said the foreman of the shop
where Tom applied, and where the machinery made so much noise
that every one had to shout to be heard. “It’s a good trade, and you
can earn good wages at it.”
“How much do you pay?” asked Tom.
“Pay? We don’t pay anything the first year,” answered the foreman,
in apparent surprise at the question. “I thought you wanted to learn
the trade.”
“I’d like to,” said Tom, “but I want to live while I’m learning it. A trade
wouldn’t do me much good if I starved to death, and I’d do that if I
didn’t get some money.”
“I guess you won’t suit,” was the comment, as the foreman turned
back to the lathe which he had stopped while he talked to Tom.
“No, I guess not,” was our hero’s comment.
He had exhausted the possibilities of the advertising list, so he
strolled around in the streets where there were many office buildings,
hoping he might see some boys he knew, who could tell him where
he might apply for work, or where he might see that magical sign
“Boy Wanted” hanging in front of a store or office.
He did see two signs, but the places were meant for smaller lads
than Tom—boys who had parents to support them—and who would
be content with two or three dollars a week.
“I guess this is going to be a poor year for boys,” thought Tom, as he
went over to a little park, where, sitting on a bench, he ate his lunch.
He spent five cents for a cup of coffee and a bun at a street stand,
and felt somewhat better after it, for the day was cold.
“There’s a big building,” mused the boy, as he looked at one just
across from the little park. “There must be a couple of hundred
offices in it. Now they need boys in an office, and out of the two
hundred there ought to be a place for me. I’m going to ask in every
office in that building.”
Tom did not know how much of a task he had set for himself, but he
started bravely in, beginning on the ground floor, and working his
way up.
In some places he was politely told that there was no opening for
him. In others he was gruffly given the same information, though, by
this time, he was getting hardened to rebuffs.
“Well, I’ve asked in twenty-five places,” he mused. “Here goes for the
twenty-sixth.”
He entered an office marked “Real Estate and Insurance.” A rather
pretty girl was pounding away at a typewriter.
“Do you want a boy?” asked Tom, smiling, in spite of his weariness.
“Do I want a boy?” she asked wonderingly. “Why, no. Are you a
messenger boy? I didn’t ring for any.”
“I’m looking for work,” explained Tom.
“Oh, I see,” she answered kindly. “I don’t know. I’ll ask——”
At that moment a man came from an inner office. Tom started at the
sight of him, for he was Barton Sandow, the brother-in-law of Dr.
Spidderkins.
“Well,” fairly growled Mr. Sandow, “what do you want here? I don’t
want any books, even if Dr. Spidderkins does waste his money on
them.”
“I haven’t any books,” replied Tom. “I called to see if you wanted a
boy. I’m looking for work.”
The lad’s answer seemed to enrage the man. He started toward our
hero, his face flaming red with passion.
“Who told you to come here?” he cried.
“No one; I just happened to come. I’m inquiring in all the offices in
the building.”
“Well, you clear out of here, you young gutter-pup!” fairly shouted
Barton Sandow. “I don’t want a boy, and if I did I shouldn’t hire you!
Get out of here! Do you understand! Clear out, and don’t you dare
come in again!”
The pretty typewriter girl shrank back afrightened, and Tom, not
knowing what to make of the outburst, opened the door and went
out.
“There’s something wrong with Mr. Sandow,” he said, for the
needlessly cruel words rankled in his mind. “There was no occasion
for him to speak like that. I pity Dr. Spidderkins, living with that man.
There’s something queer about it. I wonder what it is?”
CHAPTER VIII
DR. SPIDDERKINS’ POCKETBOOK
Tom tried to keep up a cheerful spirit when he went home that night,
tired and discouraged with his fruitless search for work.
“No luck, Tom?” asked his mother, who, in spite of his efforts at
concealment, could almost read his thoughts.
“No, but I’ll find a place to-morrow, mother. Is there any work I can
take home for you?”
“Yes; here is a skirt I have just finished for Mrs. Wellderly, the
minister’s wife. She is usually good pay, and I have written her a little
note, asking to please send the money by you.”
“I wish I was earning money for you, mother.”
“Never mind, Tom. I have had an unusual lot of sewing to do lately,
and we are making out fairly well. Now here is the skirt. Carry it
carefully.”
She handed the bundle to Tom, who grasped it as if it was a package
of books, placing it under one arm.
“Mercy! Goodness sakes alike! Don’t do that!” cried his aunt.
“What’s the matter?” asked Tom innocently. “Am I spilling any of the
fol-de-rols?”
“No; but you’ll crush the ruffle all out of shape!” explained his mother.
“Hold it this way, Tom,” and she showed him how he ought to carry
the parcel.
Tom safely delivered his mother’s work, and received the money
from the minister’s wife.
“Tell your mother to call and see me,” the lady said to the boy. “A
friend of mine wants some fine sewing done, and I think she would
like Mrs. Baldwin’s work.”
“I will,” promised Tom.
Refreshed by a good night’s sleep, though he was awake a little
longer than usual, wondering what the day would bring forth, Tom
arose early the next morning, determined to leave no chance untried
to get a place to work. He looked over the advertisements in the
paper, and picked out several.
He found, to his regret, however, that in most of the places where
boys or young men were wanted, that experience in some line of
industry was necessary. This was particularly true of the shops and
stores. In the offices this was not quite so requisite, but office
positions were very scarce.
“I think I’ll try some of the book stores,” thought Tom, when noon
came, and he had had no success. “I had a little experience there,
and it ought to be worth something. Any way,” he added, as he
smiled at the recollection, “I know there are two Brownings, a poet
and a baseball player.”
He turned into Milk Street, where was located Townsend’s
Emporium, but he knew it was no use to apply there. He recalled that
there was a second-hand book store, further down the street, and he
decided to try his luck there.
It was quite a different place from the neatly-kept shop where he had
formerly worked, and there was a curious, musty smell about it,
many old volumes being ranged about on the shelves.
“Do you want a boy?” asked Tom, of the proprietor.
“Why? Did you see a sign out in front?” inquired the man.
“A sign? No. Why?”
“Well, sometimes the boys of the neighborhood hang a sign out in
front to annoy me. They know I never hire a boy. They do it for a
joke, and several lads, in need of work, have been fooled by it.”
“I don’t think that’s a very good joke,” remarked Tom.
“Neither do I,” agreed the proprietor. “No, I don’t want a boy, but I’m
glad there’s no foolish sign out in front. How did you come to ask in
here?”
“Well, I used to be in Townsend’s store, and as I need work, and
every place seems to be one where experience is needed, I thought
I’d try a book store.”
“I’m sorry,” went on the man more kindly. “I can’t afford to keep a
helper. There’s very little profit in second-hand books, and to hire a
boy would eat it all up. I need a boy quite often to deliver books, but I
can’t afford to hire one regularly.”
“How often do you need one?”
“Well, about once a day. In fact I wish I had one now to take some
books to a man who lives three miles from here. I’ll give you fifty
cents and your car fare if you’ll deliver them.”
“I’ll do it,” said Tom, glad of the chance to earn a half dollar.
“Wait a minute, and I’ll wrap them up.”
Tom was soon ready to start, carrying quite a heavy bundle of books.
As he passed out of the store, in front of which were two big tables,
with bargains in second-hand books on them, he saw a familiar
figure reading a tattered volume.
“How do you do, Dr. Spidderkins!” greeted Tom, as he recognized
the aged physician.
“Eh? What’s that? Oh, it’s—I’ve forgotten—no—I remember now,
you’re William Henderson, aren’t you?”
“No, sir; I’m Thomas Baldwin.”
“Oh, yes. You’re in the Emporium. I remember now. My memory
must be coming back.”
“I used to be there,” replied Tom, “but there was no work for me after
the holidays. I’m doing odd jobs. Just now I’m carrying books for the
man who owns this place.”
“Ah, that’s a fine job, carrying books,” commented the old gentleman.
“You are diffusing knowledge, my young friend. A very noble calling.
Now I can only read books, I can’t carry them about any more. I am
reading a very fine book now. It seems to be quite rare. It tells how
the ancient Greeks had the primitive idea of raising chickens by
means of hot water pipes—something on the order of our modern
incubators. It’s a very valuable book. I don’t recollect when I have
found one more valuable, of its kind. Yes, once; the same day I
discovered a copy of Milton’s Paradise Lost, in an old book store, I
came across one worth almost as much as this. That was—um—er
—dear me—I’m afraid I can’t recall what it was. But I’ll recollect it
shortly. I must purchase this book before I forget it.”
Tom watched the old gentleman start into the store, reading on the
way the book in which he was so interested. Then Tom saw
something else. Dr. Spidderkins’ pocketbook—an old-fashioned
wallet—was half-way out of his pocket, and likely to drop to the
sidewalk.
Our hero sprang forward to reach the wallet before it should fall. He
grasped it, and was pulling it from the doctor’s pocket, intending to
restore it to him, when he was startled to hear a voice exclaim:
“Ah! You young rascal, I caught you in the very act!”
Tom turned, with the pocketbook in his hand, to behold Barton
Sandow confronting him.
“What do you mean?” asked the boy.
“What do I mean? You’ll soon see what I mean? Trying to steal the
doctor’s wallet, eh? I’ll have you arrested!”
“I wasn’t trying to steal it!” declared Tom, indignantly. “It was falling
out of his pocket, and I caught it to give it back to him.”
“That’s a likely story! You’re a thief; that’s what you are!”
“What’s that? What’s the matter?” asked the aged physician,
suddenly turning, as he became aware that something unusual had
happened.
“This boy from the book store has just stolen your pocketbook!” said
Mr. Sandow. “He’s got it in his hand now.”
“My pocketbook! Bless my soul! So it is; and I have a hundred
dollars in it!”
“I didn’t steal it!” cried Tom again. “It was dropping out, and I caught
it!”
“Hold him, doctor, until I get an officer!” called Mr. Sandow, as he
looked down the street, and saw a policeman approaching. “We’ll
soon have him behind the bars!”
CHAPTER IX
TOM LEARNS SOMETHING
Poor Tom was much distressed. What he meant to be an act

calculated to benefit the old doctor, was likely to turn to his
disadvantage, for he could not but admit that appearances were
against him. It did look, to a casual observer, as though he had taken
the pocketbook and was about to run away with it.
“This boy a thief?” exclaimed Dr. Lemuel Spidderkins as he looked at
Tom. “I don’t believe it! He’s the boy who brought me the books. He’s
an honest lad if ever I saw one.”
“Well, your eyesight isn’t very good,” remarked Mr. Sandow
sneeringly. “I saw him steal the pocketbook.”
“Oh, it’s my pocketbook you’re talking about, is it?” asked the doctor.
“Certainly. What did you think we were speaking about?” asked his
brother-in-law.
“Why, I thought you meant one of these books. Bless my soul, that is
my pocketbook. I forgot about it for the moment, I was thinking so
much about this book.”
Tom did not know what to make of the aged man. Certainly his
memory was very short, for in one breath he talked of his wallet, and
the next he forgot he had mentioned it.
“Better look and see if he took any of the money out,” suggested Mr.
Sandow. “The policeman will be here in a minute.”
“I didn’t take any money!” insisted Tom.
The aged physician opened the wallet and examined it.
“Well, if this isn’t a queer thing!” he exclaimed. “I meant to put a
hundred dollars in it this morning, to buy a rare copy of Gibbon’s

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Foundations of Finance (Pearson

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Foundations of Finance John D. Martin

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Fundamentals of Investing (Pearson Series in Finance) –

PART 1 The Scope and Environment

PART 2 The Valuation of Financial Assets 152

PART 3 Investment in Long-Term Assets 326

PART 4 Capital Structure and Dividend Policy 406

PART 5 Working-Capital Management and International

PART 1 The Scope and Environment

1 An Introduction to the Foundations of Financial

Chapter Summaries 18 • Review Questions 20 • Mini Case 21

2 The Financial Markets and Interest Rates 22

Interest Rate Determinants in a Nutshell 38

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

3 Understanding Financial Statements and Cash

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

Appendix 3A: Free Cash Flows 100

Study Problems 104

4 Evaluating a Firm’s Financial Performance 106

The Limitations of Financial Ratio Analysis 138

Chapter Summaries 139 • Review Questions 142 • Study Problems 142

PART 2 The Valuation of Financial Assets 152

5 The Time Value of Money 152

Chapter Summaries 184 • Review Questions 187 • Study Problems 187

6 The Meaning and Measurement of Risk

Chapter Summaries 225 • Review Questions 229 • Study Problems 229

7 The Valuation and Characteristics

Terminology and Characteristics of Bonds 239

Chapter Summaries 260 • Review Questions 263 • Study Problems 264

8 The Valuation and Characteristics

Chapter Summaries 287 • Review Questions 290 • Study Problems 290

9 The Cost of Capital 294

Calculating Divisional Costs of Capital 311

Chapter Summaries 317 • Review Questions 319 • Study Problems 320

PART 3 Investment in Long-Term Assets 326

10 Capital-Budgeting Techniques and Practice 326

Chapter Summaries 356 • Review Questions 359 • Study Problems 359

11 Cash Flows and Other Topics in Capital

Risk and the Investment Decision 385

Chapter Summaries 394 • Review Questions 396 • Study Problems 396

Appendix 11A: The Modified Accelerated Cost

Study Problems 405

PART 4 Capital Structure and Dividend Policy 406

12 Determining the Financing Mix 406

Chapter Summaries 436 • Review Questions 439 • Study Problems 439

13 Dividend Policy and Internal Financing 444

The Dividend Decision in Practice 452

Chapter Summaries 459 • Review Questions 461 • Study Problems 462

PART 5 Working-Capital Management and International

14 Short-Term Financial Planning 466

Chapter Summaries 477 • Review Questions 478 • Study Problems 479

15 Working-Capital Management 486

Secured Sources: Accounts-Receivable Loans 503

Chapter Summaries 506 • Review Questions 509 • Study Problems 510

16 International Business Finance 514

Chapter Summaries 530 • Review Questions 532 • Study Problems 533

Web 17 Cash, Receivables, and Inventory Management

Web Appendix A Using a Calculator