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Corporate Finance Canadian Edition & 4 More Prof Stephen A. Ross (Author) full chapter instant download
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CORPORATE
FINANCE
EIGHTH CANADIAN EDITION
Stephen A. Ross
Sloan School of Management, Massachusetts Institute of Technology
Randolph W. Westerfield
Marshall School of Business, University of Southern California
Jeffrey F. Jaffe
Wharton School of Business, University of Pennsylvania
Gordon S. Roberts
Schulich School of Business, York University
Hamdi Driss
Sobey School of Business, St. Mary’s University
Corporate Finance
Eighth Canadian Edition
Copyright © 2019, 2015, 2011, 2008, 2005, 2003, 1999, 1995 by McGraw-Hill Ryerson Limited. All rights reserved. No part
of this publication may be reproduced or transmitted in any form or by any means, or stored in a database or retrieval system,
without the prior written permission of McGraw-Hill Ryerson Limited, or in the case of photocopying or other reprographic
copying, a licence from The Canadian Copyright Licensing Agency (Access Copyright). For an Access Copyright licence, visit
www.accesscopyright.ca or call toll free to 1-800-893-5777.
The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an
endorsement by the authors or McGraw-Hill Ryerson, and McGraw-Hill Ryerson does not guarantee the accuracy of information
presented at these sites.
ISBN-13: 978-1-25-927011-6
ISBN-10: 1-25-927011-4
1 2 3 4 5 6 7 8 9 0 TCP 1 2 3 4 5 6 7 8 9
Care has been taken to trace ownership of copyright material contained in this text; however, the publisher will welcome any
information that enables it to rectify any reference or credit for subsequent editions.
STEPHEN A. ROSS Sloan School of Management, trading, where he showed both that corporate insiders earn
Massachusetts Institute of Technology. Stephen Ross is the abnormal profits from their trades and that regulation has
Franco Modigliani Professor of Financial Economics at the little effect on these profits. He has also made contributions
Sloan School of Management, Massachusetts Institute of concerning initial public offerings, regulation of utilities, the
Technology. One of the most widely published authors in behaviour of marketmakers, the fluctuation of gold prices, the
finance and economics, Professor Ross is recognized for his theoretical effect of inflation on the interest rate, the empiri-
work in developing the arbitrage pricing theory, as well as for cal effect of inflation on capital asset prices, the relationship
having made substantial contributions to the discipline through between small capitalization stocks and the January effect,
his research in signalling, agency theory, option pricing, and the and the capital structure decision.
theory of the term structure of interest rates, among other top-
ics. A past president of the American Finance Association, he GORDON S. ROBERTS Schulich School of Business,
currently serves as an associate editor of several academic and York University. Gordon Roberts was a Canadian Imperial
practitioner journals. He is a trustee of CalTech and a director Bank of Commerce Professor of Financial Services at the
of the College Retirement Equity Fund (CREF), Freddie Mac, Schulich School of Business, York University. A winner of
and Algorithmics Inc. He is also the co-chairman of Roll and numerous teaching awards, his extensive experience included
Ross Asset Management Corporation. finance classes for undergraduate and MBA students, execu-
tives, and bankers in Canada and internationally. Professor
RANDOLPH W. WESTERFIELD Marshall School of Roberts conducted research in corporate finance and bank-
Business, University of Southern California. Randolph W. ing. He served on the editorial boards of several Canadian
Westerfield is Dean of the University of Southern California’s and international academic journals. Professor Roberts was
Marshall School of Business and holder of the Robert R. a consultant to a number of regulatory bodies responsible
Dockson Dean’s Chair of Business Administration. for the oversight of financial institutions and utilities.
He came to USC from the Wharton School, University Gordon Roberts passed away in March 2017 and his many
of Pennsylvania, where he was the chairman of the finance contributions to education and finance will be missed.
department and a member of the finance faculty for 20 years.
He is a member of several public company boards of direc- HAMDI DRISS Sobey School of Business, Saint Mary’s
tors, including Health Management Associates Inc., William University. Hamdi Driss is an Assistant Professor of Finance
Lyon Homes, and the Nicholas Applegate growth fund. at the Sobey School of Business, Saint Mary’s University.
His areas of expertise include corporate financial policy, His experience includes teaching corporate finance for
investment management, and stock market price behaviour. undergraduate and Master of Finance students. A holder of
several research grants, Professor Driss conducts research on
JEFFREY F. JAFFE Wharton School of Business, corporate finance and financial intermediation. Notably, he
University of Pennsylvania. Jeffrey F. Jaffe has been a fre- has made contributions to research on the certification func-
quent contributor to finance and economic literature in such tion of credit rating agencies and the quality of credit rat-
journals as the Quarterly Economic Journal, The Journal of ings under competition. His recent work was published in the
Finance, The Journal of Financial and Quantitative Analysis, Journal of Corporate Finance. Professor Driss has served as
The Journal of Financial Economics, and The Financial a referee for several Canadian and international academic
Analysts Journal. His best-known work concerns insider journals.
IN ME M O R IA M
We at McGraw-Hill Education Canada lost one of our most esteemed authors with the passing of
Gordon S. Roberts in March of 2017. Gordon was a professor emeritus of finance at the Schulich
School of Business at York University and a McGraw-Hill author for many years.
Gordon S. Roberts will be remembered as an extremely creative and thoughtful scholar with
a rigorous approach to questions of great importance. His contributions to the field of finance are
unquestioned and are reflected in his outstanding international reputation, research contributions,
and many awards and honours. In particular, Gordon will be remembered for making significant
contributions to the current textbook. His expertise and rigorous approach were key to making this
textbook exciting, accurate, fair, well-paced, and immediately useful.
Prior to development work on this eighth Canadian edition text, our very own portfolio manager,
Alwynn Pinard, had the pleasure of working closely with Gordon. Of him she says, “Gordon’s profes-
sionalism, adherence to deadlines and commitment to quality were all attributes that endeared him to
us here at McGraw-Hill Education and created the Canadian resource you are reading, today. Thank
you, Gordon. We will miss your dedication to your work and your students and perhaps most of all,
your warmth and wit.”
On behalf of the entire staff at McGraw-Hill Education who had the pleasure of working with
Gordon personally, or the pleasure of working on all the legacy projects he helped to build, we offer
our deepest sympathies to Gordon’s wife, Sonita, and his family. Gordon’s contributions to learning
will be treasured and never forgotten.
BRIEF CONTE N TS
PA RT 3 PA RT 7
Risk 267 Financial Planning and Short-Term Finance 724
10 Risk and Return: Lessons From Market History 267 27 Short-Term Finance and Planning 724
Appendix 10A The U.S. Equity Risk Premium: 28 Cash Management 751
Historical and International Perspectives
(Available on Connect) 29 Credit Management 768
11 Risk and Return: The Capital Asset Pricing Model 290 Appendix 29A Inventory Management
(Available on Connect)
Appendix 11A Is Beta Dead? (Available on Connect)
12 An Alternative View of Risk and Return:
The Arbitrage Pricing Theory 328 PA RT 8
13 Risk, Return, and Capital Budgeting 348 Special Topics 786
Appendix 13A Economic Value Added and
30 Mergers and Acquisitions 786
the Measurement of Financial Performance 379
31 Financial Distress 821
PA RT 4 Appendix 31A Predicting Corporate Bankruptcy:
The Z-Score Model (Available on Connect)
Capital Structure and Dividend Policy 383 32 International Corporate Finance 835
14 Corporate Financing Decisions and Efficient Appendix A: Mathematical Tables
Capital Markets 383 (Available on Connect)
15 Long-Term Financing: An Introduction 414 Appendix B: Answers to Selected End-of-Chapter
16 Capital Structure: Basic Concepts 430 Problems (Available on Connect)
CON T ENTS
The teaching and practice of corporate finance in Canada are more challenging and exciting
than ever before. The last decade alone has seen fundamental changes in financial markets and
financial instruments. In the early years of the twenty-first century, announcements in the finan-
cial press about takeovers, junk bonds, financial restructuring, initial public offerings, bank-
ruptcy, and derivatives are still commonplace. In addition, there is the new recognition of “real”
options (Chapter 9), private equity and venture capital (Chapter 20), and the reappearing divi-
dend (Chapter 19). The world’s financial markets are more integrated than ever before. Both the
theory and practice of corporate finance have been moving ahead with uncommon speed, and our
teaching, as always, must keep pace.
These developments place new burdens on the teaching of corporate finance. On the one hand,
the changing world of finance makes it more difficult to keep materials up to date. On the other
hand, the teacher must distinguish the permanent from the temporary and avoid the temptation to
follow fads. Our solution to this problem is to emphasize the modern fundamentals of the theory
of finance and make the theory come to life with contemporary examples. All too often, the novice
student views corporate finance as a collection of unrelated topics that are unified largely because
they are bound together between the covers of one book. As in the previous editions, our aim is
to present corporate finance as the collaboration of a small number of integrated and powerful
institutions.
This book has been written for the introductory courses in corporate finance at the MBA level
and for the intermediate courses in many undergraduate programs. Some instructors will find this
text appropriate for the introductory course at the undergraduate level as well.
It is assumed that most students either will take, or will be concurrently enrolled in, courses in
accounting, statistics, and economics. This exposure will help students understand some of the more
difficult material. However, the book is self-contained, and prior knowledge of these areas is not
essential. The only mathematics prerequisite is basic algebra.
PEDAGOGY
Keeping the theory and concepts current is only one phase of developing our corporate finance text.
To be an effective teaching tool, the text must present the theory and concepts in a coherent way that
can be easily learned. With this in mind, we have included the following study features.
Executive Summary
Each chapter begins with a road map that describes the objectives of the chapter and how it connects
with concepts already learned in previous chapters. Real company examples that will be discussed
are highlighted in this section.
Ch a p t er 1
Introduction to Corporate Finance Preface xix
E XE CUTIV E S UMMA RY
Barrick Gold Corporation has long been known as the largest gold mining company in the world. With the recent recession,
gold prices and Barrick’s share price increased as investors sought a safe investment. However, in 2013 Barrick’s shares
plunged in value by 54 percent to a 20-year low. While the accompanying fall in the value of gold was beyond the compa-
ny’s control, the poor performance was attributed primarily to the failure of key projects, misallocation of capital resources,
and the legal mess associated with the Pascua-Lama mine in Chile. Accompanying this poor performance, the company’s
proxy circular revealed that six executives were to be compensated for a combined $47.4 million and board chair Peter
Munk was to receive $4.3 million. In addition, the company awarded a US$11.9 million signing bonus to John Thornton for
joining the company as co-chair.1 Consequently, several major shareholders of Barrick Gold Corporation invoked a “say
on pay” vote, which rejected the pay packages and led to the appointment of new independent directors and to Munk
stepping down as board chair. Recent events at Barrick Gold Corporation illustrate both the importance of governance
issues and the need for management to make key corporate finance decisions relating to the following questions:
1. What long-term investment strategy should a company take on?
2. How can cash be raised?
possible
Early in a firm’s lifecycle, when sites.
shareEurope
ownershipis considered
is of toCEO
be relatively
chair and safe, whereas
a “lead” Japan or
director) is seen as very risky.
a complete In both cases
separa-
highly concentrated, this balance of power
the company would is close
hardly tion of the
an operations
down roles
after oneofyear.
CEO and chair.
issue. However, as the company Aftergrows
doing aand prospers,
complete In Europe,
financial analysis, the tradition
Midland has come hasup been
withnot thetofollowing
place thecashCEOflows of the
and founders diversify their initial investment by bring- in the chair, in some countries by statute. However, while
alternative plans for expansion under three scenarios: pessimistic, realistic, and optimistic.
ing in new and smaller owners, the balance starts to non-executive members make up a clear majority of direc-
change. Corporate insiders, who themselves have much tors in the United States, there is a tradition in Europe for
of their human capital invested in the firm, increasingly placing a greater portion of employees on boards, which
Pessimistic Realistic Optimistic
view shareholders as a remote constituency and even as also raises conflict of interest issues.
irrelevant for the company on a daily basis.Europe By choosing $75,000
The typical defence of$100,000
having insiders on $125,000
boards is one
to diversify, shareholders for their part agree Japan to play a of efficiency: 0 the board requires
150,000CEO and200,000 other manage-
diminished role in the company’s affairs. ment input to make proper decisions. What this defence
For shareholders who diversify their investment leaves unanswered, however, is why the CEO needs a
across a broad portfolio of Ifcompanies,we ignore the thepessimistic vote onperhaps
cost of scenario, the boardJapan(letisalone the chair)
the better in order
alternative. to supply
When we take the pes-
actively monitoring the performance
simistic scenario of into account, thethe
management board
choice with his Japan
is unclear. or herappears
information.
to be riskier, but it may also offer a
Concept Questions
higher expected level of cash flow. What is risk and how can it be defined? We must try to answer this
important question. Corporate finance cannot avoid coping with risky alternatives, and much of our book
Included after each major issection
closely devoted toindeveloping
a chapter,
held corporations. Concept
methods
However, Questions
for evaluating
shareholders risky
have point
control to
opportunities.
several essential
devices material
(some more effectiveand
allow students to test their recalltoand
than others) bondcomprehension before moving
management to the self-interest forward.
of shareholders:
language: English
By
EDITH B. DAVIDSON
Pictures by
CLARA E. ATWOOD
NEW YORK
DUFFIELD AND COMPANY
1910
i. and when she got there the cupboard was bare 9
ii. not a creature was stirring, not even a mouse 21
iii. mr. bushy tail goes tobogganing 29
iv. on the wings of the north wind 39
v. at the top of the south pole 51
vi. a quilly acquaintance 63
vii. the snortling of the ring-tailed snorter 75
viii. the gentle south wind 87
And when she got there
The cupboard was bare
It had been an exceptionally cold winter, and Mr. and Mrs. Bushy
Tail had found it very difficult to keep themselves and their two small
children warm.
They had finally moved into Grandmother Chipmunk’s house tree,
which seemed to be more protected from the high winds and the
heavy snow-storms, than their own pretty little nest. The rooms were
rather small, however, and Grandmother Chipmunk snored most
awfully, so that for several nights Baby Bushy Tail could not sleep.
One cold snowy day, Mrs. Bushy Tail came into the living-room
with a very sober face.
“My dear,” she said to her husband, “the acorns and pine-cones
are nearly gone, and with the exception of a few dried apples and
lettuce leaves, there is nothing left in the cupboard.”
“Ttt, Ttt,” said Grandma Chipmunk, laying down her knitting, and
looking over her spectacles. “Whatever shall we do? Starve?”
Thereupon little Frisky, the oldest boy, set up a fearsome
squeaking, for he liked good things to eat, and did not want to starve.
Of course that started the baby off, and for a few moments no one
could hear themselves think, much less talk.
Frisky having been sent out of the room, and the baby being
pacified with an acorn-cup to play with, Mr. Bushy Tail spoke:
“There’s only one thing to do;” said he, “go across the frozen pond,
and through the woods, to either my cousin Red Squirrel’s or else to
the Chipmunks’. They will gladly lend me corn or oats enough to
feed us for another month, and by that time let us hope that Spring
will have come.”
“You’ll freeze in the deep snow,” said his wife, “or else you will be
blown to the North Pole by the fierce wind. Then I shall be a widow,
and what will the children do? Oh dear! Oh dear!” and she began to
cry.
Mr. Bushy Tail comforted her as best he could, saying that he
knew the path well, that the trees would protect him from the fierce
wind, and that he was too nimble and quick to sink and freeze in the
deep snow.
At last, he promised not to go the next morning, unless the
weather was fine, so they all went to bed in their soft mossy nests.
Not a Creature was Stirring
Not Even a Mouse
Bright and early the next morning, Mr. Bushy Tail was up, had
washed his little face and paws, and brushed out his pretty soft fur,
of which he was justly a trifle vain. The sun was shining, and
although the air was very cold, he decided it was best for him to start
for his cousin Red Squirrel’s.
His wife bundled him up in a warm sweater and socks, which she
had made him for a Christmas present. Over his shoulder he slung a
bag for the corn, and promising surely to be back in two days time,
he trotted away, after having kissed the entire family three times all
around.
The traveling was much better than he had feared it would be; and
he was fortunate enough to find a bush full of late rose-hips, from
which he made a good dinner.
The family urged him to stay to dinner, but the sky looked grey and
threatening, and Bushy Tail had a long journey before him, so he ate
a hasty luncheon, thanked Mr. Chipmunk once more for his
kindness, and with his heavy bag over his shoulder, he scurried off
as fast as he could go.
Very soon the snow began to fall, first, in large single flakes, and
then faster and thicker. Scarcely could Mr. Bushy Tail see the way;
and after bumping into first a tree, and then a big bush, he lost his
footing, scrambled about for a minute in the deep snow, and then
sank down, down, DOWN, and landed kerplunk!