Standard Edition

FUNDAMENTALS OF
CORPORATE FINANCE

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The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate
Stephen A. Ross
Franco Modigliani Professor of Finance and Economics
Sloan School of Management, Massachusetts Institute of Technology, Consulting Editor
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Standard Edition

Ninth Edition

FUNDAMENTALS OF
CORPORATE FINANCE
Stephen A. Ross
Massachusetts Institute of Technology

Randolph W. Westerfield
University of Southern California

Bradford D. Jordan
University of Kentucky

Boston Burr Ridge, IL Dubuque, IA New York San Francisco St. Louis
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FUNDAMENTALS OF CORPORATE FINANCE
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the
Americas, New York, NY, 10020. Copyright © 2010, 2008, 2006, 2003, 2000, 1998, 1995, 1993, 1991 by The
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Library of Congress Cataloging-in-Publication Data
Ross, Stephen A.
Fundamentals of corporate finance / Stephen A. Ross, Randolph W. Westerfield, Bradford
D. Jordan.—9th ed., Alternate ed.
p. cm.— (The McGraw-Hill/Irwin series in finance, insurance and real estate)
Includes index.
ISBN-13: 978-0-07-338239-5 (standard edition : alk. paper)
ISBN-10: 0-07-338239-6 (standard edition : alk. paper)
ISBN-13: 978-0-07-724612-9 (alternate edition : alk. paper)
ISBN-10: 0-07-724612-8 (alternate edition : alk. paper)
1. Corporations—Finance. I. Westerfield, Randolph. II. Jordan, Bradford D. III. Title.
HG4026.R677 2010
658.15—dc22
2008053546

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To our families and friends with love and gratitude.
S.A.R. R.W.W. B.D.J.

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About the Authors

STEPHEN A. ROSS
Sloan School of Management, Franco Modigliani Professor of Finance and Economics, Massachusetts
Institute of Technology

Stephen A. Ross is the Franco Modigliani Professor of Finance and
Economics at the Sloan School of Management, Massachusetts Institute of Technology. One of the most widely published authors in finance
and economics, Professor Ross is recognized for his work in developing the Arbitrage Pricing Theory and his substantial contributions to
the discipline through his research in signaling, agency theory, option
pricing, and the theory of the term structure of interest rates, among
other topics. A past president of the American Finance Association, he
currently serves as an associate editor of several academic and practitioner journals. He is a trustee of CalTech.
RANDOLPH W. WESTERFIELD
Marshall School of Business, University of Southern California

Randolph W. Westerfield is Dean Emeritus of the University of Southern California’s Marshall School of Business and is the Charles B.
Thornton Professor of Finance.
He came to USC from the Wharton School, University of
Pennsylvania, where he was the chairman of the finance department
and a member of the finance faculty for 20 years. He is a member of

several public company boards of directors including Health Management Associates, Inc., and the Nicholas Applegate growth fund. His
areas of expertise include corporate financial policy, investment management, and stock market price behavior.
BRADFORD D. JORDAN
Gatton College of Business and Economics, University of Kentucky

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

vii

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Preface from the Authors
When the three of us decided to write a book, we were united by one strongly held principle: Corporate finance should
be developed in terms of a few integrated, powerful ideas. We believed that the subject was all too often presented as
a collection of loosely related topics, unified primarily by virtue of being bound together in one book, and we thought
there must be a better way.

One thing we knew for certain was that we didn’t want to write a “me-too” book. So, with a lot of help, we took a
hard look at what was truly important and useful. In doing so, we were led to eliminate topics of dubious relevance,
downplay purely theoretical issues, and minimize the use of extensive and elaborate calculations to illustrate points that
are either intuitively obvious or of limited practical use.
As a result of this process, three basic themes became our central focus in writing Fundamentals of Corporate Finance:

AN EMPHASIS ON INTUITION
We always try to separate and explain the principles at work on a common sense, intuitive level before launching into
any specifics. The underlying ideas are discussed first in very general terms and then by way of examples that illustrate
in more concrete terms how a financial manager might proceed in a given situation.

A UNIFIED VALUATION APPROACH
We treat net present value (NPV) as the basic concept underlying corporate finance. Many texts stop well short of consistently integrating this important principle. The most basic and important notion, that NPV represents the excess of
market value over cost, often is lost in an overly mechanical approach that emphasizes computation at the expense of
comprehension. In contrast, every subject we cover is firmly rooted in valuation, and care is taken throughout to explain
how particular decisions have valuation effects.

A MANAGERIAL FOCUS
Students shouldn’t lose sight of the fact that financial management concerns management. We emphasize the role of
the financial manager as decision maker, and we stress the need for managerial input and judgment. We consciously
avoid “black box” approaches to finance, and, where appropriate, the approximate, pragmatic nature of financial analysis is made explicit, possible pitfalls are described, and limitations are discussed.
In retrospect, looking back to our 1991 first edition IPO, we had the same hopes and fears as any entrepreneurs. How
would we be received in the market? At the time, we had no idea that just 18 years later, we would be working on a ninth
edition. We certainly never dreamed that in those years we would work with friends and colleagues from around the world
to create country-specific Australian, Canadian, and South African editions, an International edition, Chinese, French,
Polish, Portuguese, Thai, Russian, Korean, and Spanish language editions, and an entirely separate book, Essentials of
Corporate Finance, now in its sixth edition.
Today, as we prepare to once more enter the market, our goal is to stick with the basic principles that have brought
us this far. However, based on the enormous amount of feedback we have received from you and your colleagues, we
have made this edition and its package even more flexible than previous editions. We offer flexibility in coverage, by continuing to offer two editions, and flexibility in pedagogy, by providing a wide variety of features in the book to help students to learn about corporate finance. We also provide flexibility in package options by offering the most extensive

collection of teaching, learning, and technology aids of any corporate finance text. Whether you use only the textbook,
or the book in conjunction with our other products, we believe you will find a combination with this edition that will meet
your current as well as your changing course needs.
Stephen A. Ross
Randolph W. Westerfield
Bradford D. Jordan
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Coverage
This book was designed and developed explicitly for a first course in business or corporate finance, for
both finance majors and non-majors alike. In terms of background or prerequisites, the book is nearly selfcontained, assuming some familiarity with basic algebra and accounting concepts, while still reviewing
important accounting principles very early on. The organization of this text has been developed to give
instructors the flexibility they need. Two important changes have been made to the ninth edition chapter
organization, one of which is the exciting addition of a behavioral finance chapter in the Alternate Edition.
Also, the chapter on options and corporate finance, Chapter 14 in the eighth edition, has been moved to
the Alternate Edition.
The following grid presents, for each chapter, some of the most significant features as well as a few
selected chapter highlights of the ninth edition of Fundamentals. Of course, in every chapter, opening
vignettes, boxed features, in-chapter illustrated examples using real companies, and end-of-chapter material have been thoroughly updated as well.
Chapters

PART 1

Selected Topics of Interest


Overview of Corporate Finance

Chapter 1
Introduction to Corporate
Finance

Chapter 2
Financial Statements, Taxes,
and Cash Flow

PART 2

Benefits to You

Sarbanes–Oxley.
Goal of the firm and agency problems.

Stresses value creation as the most fundamental
aspect of management and describes agency
issues that can arise.

Ethics, financial management, and
executive compensation.

Brings in real-world issues concerning conflicts
of interest and current controversies surrounding
ethical conduct and management pay.

Minicase: Cash Flows and Financial
Statements at Sunset Boards, Inc.


Reinforces key cash flow concepts in a smallbusiness setting.

Cash flow vs. earnings.

Clearly defines cash flow and spells out the
differences between cash flow and earnings.

Market values vs. book values.

Emphasizes the relevance of market values
over book values.

Financial Statements and Long-Term Financial Planning

Chapter 3
Working with Financial
Statements

Ratios: PEG, price-to-sales, and
Tobin’s Q.
Expanded Du Pont analysis.

Expands the basic Du Pont equation to better
explore the interrelationships between operating
and financial performance.

Du Pont analysis for real companies
using data from S&P Market Insight.


Analysis shows students how to get and use realworld data, thereby applying key chapter ideas.

Ratio and financial statement analysis
using smaller firm data.

Uses firm data from RMA to show students how
to actually get and evaluate financial statements
benchmarks.

Understanding financial statements.

Thorough coverage of standardized financial
statements and key ratios.

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Chapters
Chapter 4
Long-Term Financial Planning
and Growth

PART 3

Selected Topics of Interest


Benefits to You

Expanded discussion on sustainable
growth calculations.

Illustrates the importance of financial planning in
a small firm.

Minicase: Planning for Growth at S&S Air.
Explanation of alternative formulas for
sustainable and internal growth rates.

Explanation of growth rate formulas clears up a
common misunderstanding about these formulas
and the circumstances under which alternative
formulas are correct.

Thorough coverage of sustainable
growth as a planning tool.

Provides a vehicle for examining the interrelationships between operations, financing, and growth.

Long-range financial planning.

Covers percentage of sales approach to creating
pro forma statements.

Valuation of Future Cash Flows

Chapter 5

Introduction to Valuation:
The Time Value of Money

First of two chapters on time value of
money.

Chapter 6
Discounted Cash Flow
Valuation

Growing annuities and perpetuities.
Second of two chapters on time value
of money.
New minicase: The MBA Decision.

Chapter 7
Interest Rates and Bond
Valuation

Inflation and present values.

Chapter 8
Stock Valuation

Relatively short chapter introduces just the basic
ideas on time value of money to get students
started on this traditionally difficult topic.

Covers more advanced time value topics with
numerous examples, calculator tips, and Excel

spreadsheet exhibits. Contains many real-world
examples.

“Clean” vs. “dirty” bond prices and
accrued interest.

Clears up the pricing of bonds between coupon
payment dates and also bond market quoting
conventions.

NASD’s new TRACE system and
transparency in the corporate bond
market.

Up-to-date discussion of new developments in
fixed income with regard to price, volume, and
transactions reporting.

“Make-whole” call provisions.
Minicase: Financing S&S Air’s
Expansion Plans with a Bond Issue.

Up-to-date discussion of a relatively new
type of call provision that has become very
common.

Bond valuation.

Complete coverage of bond valuation and bond
features.


Interest rates.

Discusses real versus nominal rates and the
determinants of the term structure.

Minicase: Stock Valuation at
Ragan, Inc.

Examines the debt issuance process for a
small firm.

Stock valuation.

Thorough coverage of constant and nonconstant growth models.

NYSE and NASDAQ Market
Operations.

Up-to-date description of major stock market
operations

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Coverage

Chapters

PART 4

Selected Topics of Interest

Benefits to You

Modified internal rate of return (MIRR)
New case: Bullock Gold Mining.
First of three chapters on capital
budgeting.

Relatively short chapter introduces key ideas on
an intuitive level to help students with this
traditionally difficult topic.

NPV, IRR, payback, discounted
payback, and accounting rate of return.

Consistent, balanced examination of advantages
and disadvantages of various criteria.

Project cash flow.

Thorough coverage of project cash flows and the
relevant numbers for a project analysis.

Alternative cash flow definitions.


Emphasizes the equivalence of various formulas,
thereby removing common misunderstandings.

Special cases of DCF analysis.

Considers important applications of chapter tools.

Minicase: Conch Republic Electronics.

Analyzes capital budgeting issues and
complexities.

Sources of value.

Stresses the need to understand the economic
basis for value creation in a project.

Scenario and sensitivity “what-if”
analyses.

Illustrates how to actually apply and interpret
these tools in a project analysis.

Break-even analysis.

Covers cash, accounting, and financial breakeven levels.

Capital Budgeting

Chapter 9

Net Present Value and Other
Investment Criteria

Chapter 10
Making Capital Investment
Decisions

Chapter 11
Project Analysis and Evaluation

PART 5

(continued)

Risk and Return

Chapter 12
Some Lessons from Capital
Market History

Chapter 13
Return, Risk, and the Security
Market Line

Minicase: A Job at S&S Air.
Expanded discussion of geometric vs.
arithmetic returns.

Discusses calculation and interpretation of
geometric returns. Clarifies common misconceptions regarding appropriate use of

arithmetic vs. geometric average returns.

Capital market history.

Extensive coverage of historical returns,
volatilities, and risk premiums.

Market efficiency.

Efficient markets hypothesis discussed along
with common misconceptions.

New! The equity risk premium.

New section discusses the equity premium
puzzle and latest international evidence.

Minicase: The Beta for ColgatePalmolive.
Diversification, systematic and unsystematic risk.

Illustrates basics of risk and return in a
straightforward fashion.

Beta and the security market line.

Develops the security market line with an intuitive
approach that bypasses much of the usual
portfolio theory and statistics.

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Chapters

Selected Topics of Interest

Benefits to You

PART 6 Cost of Capital and Long-Term Financial Policy
Chapter 14
Cost of Capital

Chapter 15
Raising Capital

Chapter 16
Financial Leverage and Capital
Structure Policy

Chapter 17
Dividends and Dividend Policy

Internal equity and flotation costs.
Geometric vs. arithmetic growth rates.

Both approaches are used in practice. Clears up

issues surrounding growth rate estimates.

Cost of capital estimation.

Contains a complete, Web-based illustration of
cost of capital for a real company.

Minicase: S&S Air Goes Public.
Dutch auction IPOs.

Explains uniform price auctions using recent
Google IPO as an example.

IPO “quiet periods.”

Explains the SEC’s quiet period rules.

Rights vs. warrants.

Clarifies the option-like nature of rights prior
to their expiration dates.

IPO valuation.

Extensive, up-to-date discussion of IPOs,
including the 1999–2000 period.

The pecking-order theory of capital
structure.
Minicase: Stephenson Real Estate

Recapitalization.
Basics of financial leverage.

Illustrates effect of leverage on risk and return.

Optimal capital structure.

Describes the basic trade-offs leading to an
optimal capital structure.

Financial distress and bankruptcy.

Briefly surveys the bankruptcy process.

Minicase: Electronic Timing, Inc.

Analyzes cost of capital estimation for a nonpublic firm.

Very recent survey evidence on
dividend policy.

New survey results show the most important (and
least important) factors considered by financial
managers in setting dividend policy.

Effect of new tax laws.

Discusses implications of new, lower dividend,
and capital gains rates.


Dividends and dividend policy.

Describes dividend payments and the factors
favoring higher and lower payout policies.

New! Optimal payout policy.

Extensive discussion of the latest research and
survey evidence on dividend policy, including
life-cycle theory.

Stock repurchases.

Thorough coverage of buybacks as an alternative
to cash dividends.

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Coverage
Chapters

PART 7

(continued)


Selected Topics of Interest

Benefits to You

Short-Term Financial Planning and Management

Chapter 18
Short-Term Finance
and Planning

Operating and cash cycles.

Stresses the importance of cash flow timing.

Short-term financial planning.

Illustrates creation of cash budgets and potential
need for financing.

Chapter 19
Cash and Liquidity
Management

Check Clearing Act of the 21st
Century.

Chapter 20
Credit and Inventory
Management


PART 8

Minicase: Cash Management at Webb
Corporation.
Float management.

Thorough coverage of float management and
potential ethical issues.

Cash collection and disbursement.

Examination of systems used by firms to handle
cash inflows and outflows.

Minicase: Credit Policy at Howlett
Industries.

Evaluates working capital issues for a small firm.

Credit management

Analysis of credit policy and implementation.

Inventory management

Brief overview of important inventory concepts.

Topics in Corporate Finance

Chapter 21

International Corporate Finance

Minicase: S&S Air Goes
International.
Foreign exchange.

Covers essentials of exchange rates and their
determination.

International capital budgeting.

Shows how to adapt basic DCF approach
to handle exchange rates.

Exchange rate and political risk.

Discusses hedging and issues surrounding
sovereign risk.

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Study Features
To meet the varied needs of its intended audience, Fundamentals of Corporate Finance is rich in valuable
learning tools and support.


CHAPTER-OPENING VIGNETTES
Vignettes drawn from real-world events introduce students to the chapter concepts. For examples, see
Chapter 4, page 87; Chapter 5, page 119.

CHAPTER LEARNING OBJECTIVES
LEARNING OBJECTIVES

New to this edition, this feature maps out the
topics and learning goals in every chapter. Each
end-of-chapter problem and test bank question
is linked to a learning objective, to help you
organize your assessment of knowledge and
comprehension.

After studying this chapter, you
should understand:

Capital Budgeting

PA RT 4

10

MAKING CAPITAL
INVESTMENT
DECISIONS

IS THERE GREEN IN GREEN? General Electric

LO1 How to determine the

relevant cash flows for a
proposed project.
LO2 How to determine if a
project is acceptable.
LO3 How to set a bid price for
a project.
LO4 How to evaluate the
equivalent annual cost of
a project.

As you no doubt recognize from your study of the pre-

(GE) thinks so. Through its “Ecomagination” program,

vious chapter, GE’s decision to develop and market green

the company planned to double research and

technology represents a capital budgeting decision. In

development spending on green products, from

this chapter, we further investigate such decisions, how

$700 million in 2004 to $1.5 billion in 2010. With

they are made, and how to look at them objectively.

products such as a hybrid railroad locomotive


This chapter follows up on our previous one by delv-

(described as a 200-ton, 6,000-horsepower “Prius on

ing more deeply into capital budgeting. We have two

rails”), GE’s green initiative seems to be paying off.

main tasks. First, recall that in the last chapter, we saw

Revenue from green products was $14 billion in 2007,

that cash flow estimates are the critical input into a net

with a target of $25 billion in 2010. The company’s

present value analysis, but we didn’t say much about

internal commitment to reduced energy consumption

where these cash flows come from; so we will now

saved it more than $100 million from 2004 to 2007,

examine this question in some detail. Our second goal is

and the company was on target to reduce its water

to learn how to critically examine NPV estimates, and, in


consumption by 20 percent by 2012, another consid-

particular, how to evaluate the sensitivity of NPV esti-

erable cost savings.

mates to assumptions made about the uncertain future.

Master the ability to solve problems in this chapter
by using a spreadsheet. Access Excel Master on the
student Web site www.mhhe.com/rwj.

So far, we’ve covered various parts of the capital budgeting
decision. Our task in this chapter is to start bringing these
pieces together. In particular, we will show you how to “spread the numbers” for a proposed investment or project and, based on those numbers, make an initial assessment about
whether the project should be undertaken.
In the discussion that follows, we focus on the process of setting up a discounted cash
flow analysis. From the last chapter, we know that the projected future cash flows are the
key element in such an evaluation. Accordingly, we emphasize working with financial and
accounting information to come up with these figures.
In evaluating a proposed investment, we pay special attention to deciding what information is relevant to the decision at hand and what information is not. As we will see, it is easy
to overlook important pieces of the capital budgeting puzzle.

PEDAGOGICAL USE OF COLOR

FIGURE 9.8
NPV Profiles for Mutually
Exclusive Investments

70

60
50
Investment B
40
NPV ($)

This learning tool continues to be an
important feature of Fundamentals of
Corporate Finance. In almost every
chapter, color plays an extensive,
nonschematic, and largely self-evident
role. A guide to the functional use of
color is on the endsheets of the text.

Investment A

Crossover point

30
26.34
20
10

NPVB Ͼ NPVA

IRRA ϭ 24%

NPVA Ͼ NPVB
0
Ϫ10


5

10
11.1%

15

20

25

30

R(%)

IRRB ϭ 21%

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IN THEIR OWN
WORDS BOXES
This series of boxes are the
popular articles updated from
previous editions written by a

distinguished scholar or
practitioner on key topics in
the text. Boxes include essays
by Merton Miller on capital
structure, Fischer Black on
dividends, and Roger Ibbotson
on capital market history. A
complete list of “In Their Own
Words” boxes appears on
page xli.

IN THEIR OWN WORDS . . .
Jeremy J. Siegel on Stocks for the Long Run
The most fascinating characteristic about the data on real financial market returns that I collected is the
stability of the long-run real equity returns. The compound annual (geometric) real return on U.S. stocks averaged
6.8% per year from 1802 through 2007 and this return had remained remarkably stable over long-term periods.
From 1802 through 1871, the real return averaged 7.0%, from 1871, when the Cowles Foundation data became
available, through 1925, the real return on stocks averaged 6.6% per year, and since 1925, which the well-known
Ibbotson data cover, the real return has averaged 6.7%. Despite the fact that the price level has increased over
ten times since the end of the Second World War, real stock returns have still averaged 6.8%.
The long run stability of real returns on stocks is strongly indicative of mean reversion of equity return. Mean
reversion means that stock returns can be very volatile in the short run, but show a remarkable stability in the long
run. When my research was first published, there was much skepticism of the mean reversion properties of equity
market returns, but now this concept is widely accepted for stocks. If mean reversion prevails, portfolios geared
for the long-term should have a greater share of equities than short-term portfolios. This conclusion has long been
the “conventional” wisdom on investing, but it does not follow if stock returns follow a random walk, a concept
widely accepted by academics in the 1970s and 1980s.
When my data first appeared, there was also much discussion of “survivorship bias,” the fact that the U.S. stock
returns are unusually good because the U.S. was the most successful capitalist country. But three British researchers,
Elroy Dimson, Paul Marsh, and Michael Staunton, surveyed stock returns in 16 countries since the beginning of the

20th century and wrote up their results in a book entitled Triumph of the Optimists. The authors concluded that U.S.
stock returns do not give a distorted picture of the superiority of stocks over bonds worldwide.
Jeremy J. Siegel is the Russell E. Palmer Professor of Finance at The Wharton School of the University of Pennsylvania and author of
Stocks for the Long Run and The Future Investors. His research covers macroeconomics and monetary policy, financial market returns,
and long-term economic trends.

ENHANCED! WORK
THE WEB BOXES

WORK THE WEB
Bond quotes have become more available with the rise of the Internet. One site where you can find current bond
prices is cxa.marketwatch.com/finra/MarketData/Default.aspx. We went to the Web site and searched for bonds
issued by Chevron. Here is a look at part of what we found for one of the bonds:

These boxes show
students how to research
financial issues using the
Web and then how to use
the information they find to
make business decisions.
New to this edition, now all
of the Work the Web boxes
also include interactive
follow-up questions and
exercises.

The bond has a coupon rate of 7.50 percent and matures on March 1, 2043. The last sale on this bond was at a
price of 108.50 percent of par, which gives a yield to maturity of about 5.93 percent. Not only does the site provide
the most recent price and yield information, but it also provides more important information about the bond, such
as the credit rating, coupon date, call date, and call price. We’ll leave it up to you to have a look at the page and

the rest of the information available there.

Questions
1. Go to this Web site and find the bond shown above. When was this bond issued? What was the
size of the bond issue? What were the yield to maturity and price when the bond was issued?
2. When you search for Chevron bonds (CVX), you will find bonds for several companies listed.
Why do you think Chevron has bonds issued with different corporate names?

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REAL-WORLD EXAMPLES
Actual events are integrated throughout the text, tying chapter concepts to real life through
illustration and reinforcing the relevance of the material. Some examples tie into the chapter opening
vignette for added reinforcement. See Example 5.10 on page 133.

SPREADSHEET
STRATEGIES

SPREADSHEET STRATEGIES
How to Calculate Present Values with Multiple
Future Cash Flows Using a Spreadsheet

This feature introduces

students to Excel and
shows them how to set
up spreadsheets in
order to analyze
common financial
problems—a vital part
of every business
student’s education.

Just as we did in our previous chapter, we can set up a basic spreadsheet to calculate the present values of the
individual cash flows as follows. Notice that we have simply calculated the present values one at a time and added
them up:

A

B

C

D

E

1

Using a spreadsheet to value multiple future cash flows

2
3
4

5
6
7
8
9

What is the present value of $200 in one year, $400 the next year, $600 the next year, and
$800 the last year if the discount rate is 12 percent?

10
11
12
13
14
15
16
17
18
19
20
21
22

Rate:

.12

Year

Cash flows


Present values

Formula used

1
2
3
4

$200
$400
$600
$800

$178.57
$318.88
$427.07
$508.41

=PV($B$7,A10,0,ϪB10)
=PV($B$7,A11,0,ϪB11)
=PV($B$7,A12,0,ϪB12)
=PV($B$7,A13,0,ϪB13)

Total PV:

$1,432.93

=SUM(C10:C13)


Notice the negative signs inserted in the PV formulas. These just make the present values have
positive signs. Also, the discount rate in cell B7 is entered as $B$7 (an “absolute” reference)
because it is used over and over. We could have just entered “.12” instead, but our approach is more
flexible.

CALCULATOR HINTS
Brief calculator tutorials appear in selected chapters to help students
learn or brush up on their financial calculator skills. These complement
the Spreadsheet Strategies.

CALCULATOR HINTS
Annuity Present Values
To find annuity present values with a financial calculator, we need to use the PMT key (you were probably wondering what it was for). Compared to finding the present value of a single amount, there are two important differences. First, we enter the annuity cash flow using the PMT key. Second, we don’t enter anything for the future
value, FV . So, for example, the problem we have been examining is a three-year, $500 annuity. If the discount
rate is 10 percent, we need to do the following (after clearing out the calculator!):

Enter

3

10

500

N

I/Y

PMT


Solve for

PV

FV

Ϫ1,243.43

As usual, we get a negative sign on the PV.

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CONCEPT BUILDING
Chapter sections are intentionally kept short to promote a step-by-step, building block approach to
learning. Each section is then followed by a series of short concept questions that highlight the key
ideas just presented. Students use these questions to make sure they can identify and understand
the most important concepts as they read.

Concept Questions
3.3a What are the five groups of ratios? Give two or three examples of each kind.
3.3b Given the total debt ratio, what other two ratios can be computed? Explain how.

3.3c Turnover ratios all have one of two figures as the numerator. What are these
two figures? What do these ratios measure? How do you interpret the results?
3.3d Profitability ratios all have the same figure in the numerator. What is it? What do
these ratios measure? How do you interpret the results?

SUMMARY TABLES
These tables succinctly restate key principles, results, and equations. They appear whenever it is useful
to emphasize and summarize a group of related concepts. For examples, see Chapter 6, page 161.

276

PA RT 4

EXAMPLE 9.4

LABELED EXAMPLES

Capital Budgeting

Calculating the IRR
A project has a total up-front cost of $435.44. The cash flows are $100 in the first year,
$200 in the second year, and $300 in the third year. What’s the IRR? If we require an
18 percent return, should we take this investment?
We’ll describe the NPV profile and find the IRR by calculating some NPVs at different discount rates. You should check our answers for practice. Beginning with 0 percent, we have:
Discount Rate

NPV

0%


$164.56

5%

100.36

10%

46.15

15%

.00

20%

Ϫ 39.61

The NPV is zero at 15 percent, so 15 percent is the IRR. If we require an 18 percent return,
then we should not take the investment. The reason is that the NPV is negative at 18 percent (verify that it is Ϫ$24.47). The IRR rule tells us the same thing in this case. We shouldn’t
take this investment because its 15 percent return is below our required 18 percent return.

Separate numbered and titled
examples are extensively
integrated into the chapters.
These examples provide detailed
applications and illustrations of
the text material in a step-by-step
format. Each example is
completely self-contained so

students don’t have to search for
additional information. Based on
our classroom testing, these
examples are among the most
useful learning aids because they
provide both detail and
explanation.

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KEY TERMS
Key Terms are printed in bold type and defined within the text the first time they appear. They also
appear in the margins with definitions for easy location and identification by the student. See
Chapter 7, page 203 for an example.

EXPLANATORY WEB LINKS
These Web links are provided in the margins of the text. They are specifically selected to accompany
text material and provide students and instructors with a quick way to check for additional information
using the Internet.

CHAPTER 7

215

Interest Rates and Bond Valuation


If you go to the Web site and click on a particular bond, you will get a lot of information
about the bond, including the credit rating, the call schedule, original issue information,
and trade information.
As we mentioned before, the U.S. Treasury market is the largest securities market in the
world. As with bond markets in general, it is an OTC market, so there is limited transparency. However, unlike the situation with bond markets in general, trading in Treasury
issues, particularly recently issued ones, is very heavy. Each day, representative prices for
outstanding Treasury issues are reported.
Figure 7.4 shows a portion of the daily Treasury note and bond listings from the Web
site wsj.com. The entry that begins “2021 Nov 15” is highlighted. This information tells us
that the bond will mature in November of 2021. The next column is the coupon rate, which
is 8.000 percent for this bond. Treasury bonds all make semiannual payments and have a
face value of $1,000, so this bond will pay $40 per six months until it matures.

The Federal
Reserve Bank of St. Louis
maintains dozens of online
files containing macroeconomic data as well as rates
on U.S. Treasury issues. Go
to www.stls.frb.org/fred/files.

KEY EQUATIONS
Called out in the text, key equations are identified by an equation number. The list in Appendix B
shows the key equations by chapter, providing students with a convenient reference.

Based on our examples, we can now write the general expression for the value of a
bond. If a bond has (1) a face value of F paid at maturity, (2) a coupon of C paid per period,
(3) t periods to maturity, and (4) a yield of r per period, its value is:
Bond value ϭ C ϫ [1 Ϫ 1͞(1 ϩ r)t ]͞r ϩ
Bond value ϭ


Present value
of the coupons

ϩ

F͞(1 ϩ r)t
Present value
of the face amount

[7.1]

HIGHLIGHTED CONCEPTS
Throughout the text, important ideas are pulled out and presented in a highlighted box—signaling to
students that this material is particularly relevant and critical for their understanding. For examples,
see Chapter 7, page 218; Chapter 9, page 265.

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CHAPTER SUMMARY AND CONCLUSIONS
Every chapter ends with a concise, but thorough, summary of the important ideas—helping students
review the key points and providing closure to the chapter.
CHAPTER REVIEW AND SELF-TEST PROBLEMS
5.1
5.2


5.3

5.4

Calculating Future Values Assume you deposit $10,000 today in an account that
pays 6 percent interest. How much will you have in five years?
Calculating Present Values Suppose you have just celebrated your 19th birthday.
A rich uncle has set up a trust fund for you that will pay you $150,000 when you
turn 30. If the relevant discount rate is 9 percent, how much is this fund worth
today?
Calculating Rates of Return You’ve been offered an investment that will double
your money in 10 years. What rate of return are you being offered? Check your
answer using the Rule of 72.
Calculating the Number of Periods You’ve been offered an investment that will
pay you 9 percent per year. If you invest $15,000, how long until you have
$30,000? How long until you have $45,000?

ANSWERS TO CHAPTER REVIEW AND SELF-TEST PROBLEMS
5.1

5.2

We need to calculate the future value of $10,000 at 6 percent for five years. The
future value factor is:
1.065 ϭ 1.3382

CHAPTER REVIEW
AND SELF-TEST
PROBLEMS

Appearing after the
Summary and
Conclusion, each chapter
includes a Chapter
Review and Self-Test
Problem section. These
questions and answers
allow students to test
their abilities in solving
key problems related to
the chapter content and
provide instant
reinforcement.

The future value is thus $10,000 ϫ 1.3382 ϭ $13,382.26.
We need the present value of $150,000 to be paid in 11 years at 9 percent. The
discount factor is:
1͞1.0911 ϭ 1͞2.5804 ϭ .3875
The present value is thus about $58,130.

CONCEPTS REVIEW AND
CRITICAL THINKING
QUESTIONS
This successful end-of-chapter
section facilitates your students’
knowledge of key principles, as
well as intuitive understanding of
the chapter concepts. A number
of the questions relate to the
chapter-opening vignette—

reinforcing student criticalthinking skills and the learning of
chapter material.

CONCEPTS REVIEW AND CRITICAL THINKING QUESTIONS
1.
2.
3.
4.
5.

Present Value [LO2] The basic present value equation has four parts. What are they?
Compounding [LO1, 2] What is compounding? What is discounting?
Compounding and Period [LO1] As you increase the length of time involved,
what happens to future values? What happens to present values?
Compounding and Interest Rates [LO1] What happens to a future value if you
increase the rate r? What happens to a present value?
Ethical Considerations [LO2] Take a look back at Example 5.7. Is it deceptive
advertising? Is it unethical to advertise a future value like this without a disclaimer?
To answer the next five questions, refer to the TMCC security we discussed to
open the chapter.

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END-OF-CHAPTER QUESTIONS AND PROBLEMS
Students learn better when they have plenty of opportunity to practice; therefore, FCF, 9e provides extensive end-of-chapter

questions and problems. The end-of-chapter support greatly exceeds typical introductory textbooks. The questions and problems
are segregated into three learning levels: Basic, Intermediate, and Challenge. Answers to selected end-of-chapter material appear
in Appendix C. Also, all problems are available in McGraw-Hill’s Homework Manager—see page xxiv for details.
112

PA RT 2

Financial Statements and Long-Term Financial Planning
TM

QUESTIONS AND PROBLEMS
BASIC

1.

(Questions 1–15)

Pro Forma Statements [LO1] Consider the following simplified financial
statements for the Phillips Corporation (assuming no income taxes):
Income Statement
Sales
Costs
Net income

2.

Balance Sheet

$23,000
16,700


Assets

$15,800

$ 6,300

Total

$15,800

Debt
Equity
Total

$ 5,200
10,600
$15,800

Phillips has predicted a sales increase of 15 percent. It has predicted that every item
on the balance sheet will increase by 15 percent as well. Create the pro forma
statements and reconcile them. What is the plug variable here?
Pro Forma Statements and EFN [LO1, 2] In the previous question, assume
Phillips pays out half of net income in the form of a cash dividend. Costs and assets
vary with sales, but debt and equity do not. Prepare the pro forma statements and
determine the external financing needed.

END-OF-CHAPTER CASES
Located at the end of the book’s chapters, these minicases focus on real-life company situations that embody important corporate
finance topics. Each case presents a new scenario, data, and a dilemma. Several questions at the end of each case require

students to analyze and focus on all of the material they learned from each chapter.

MINICASE

Financing S&S Air’s Expansion Plans with a Bond Issue
Mark Sexton and Todd Story, the owners of S&S Air, have
decided to expand their operations. They instructed their
newly hired financial analyst, Chris Guthrie, to enlist an
underwriter to help sell $35 million in new 10-year bonds to
finance construction. Chris has entered into discussions with
Kim McKenzie, an underwriter from the firm of Raines and
Warren, about which bond features S&S Air should consider
and what coupon rate the issue will likely have.
Although Chris is aware of the bond features, he is uncertain about the costs and benefits of some features, so he isn’t
sure how each feature would affect the coupon rate of the
bond issue. You are Kim’s assistant, and she has asked you to
prepare a memo to Chris describing the effect of each of the
following bond features on the coupon rate of the bond. She
would also like you to list any advantages or disadvantages of
each feature:

QUESTIONS
1. The security of the bond—that is, whether the bond has
collateral.
2. The seniority of the bond.
3. The presence of a sinking fund.
4. A call provision with specified call dates and call prices.
5. A deferred call accompanying the call provision.
6. A make-whole call provision.
7. Any positive covenants. Also, discuss several possible

positive covenants S&S Air might consider.
8. Any negative covenants. Also, discuss several possible
negative covenants S&S Air might consider.
9. A conversion feature (note that S&S Air is not a publicly traded company).
10. A floating-rate coupon.

WEB EXERCISES (ONLINE ONLY)
For instructors interested in integrating even more online resources and problems into their course, these Web activities show
students how to learn from the vast amount of financial resources available on the Internet. In the 9th edition of Fundamentals,
these Web exercises are available to students and instructors on the Online Learning Center.

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Comprehensive Teaching
and Learning Package
This edition of Fundamentals has several options in terms of the textbook, instructor supplements, student
supplements, and multimedia products. Mix and match to create a package that is perfect for your course!

TEXTBOOK
As with the previous editions, we are offering two versions of this text. Choose the length and topics suitable for your course.
• Standard Edition (21 Chapters)
• Alternate Edition (27 Chapters)

Instructor’s CD-ROM
Keep all the supplements in one place! This CD contains all the necessary supplements—Instructor’s

Manual, Solutions, Test Bank, Computerized Test Bank, and PowerPoint—all in one useful product in an
electronic format.
• Instructor’s Manual (IM)
Prepared by Steve Dolvin, Butler University
A great place to find new lecture ideas! The annotated outline for each chapter includes lecture tips,
real-world tips, ethics notes, suggested PowerPoint slides, and, when appropriate, a video synopsis.
• Solutions Manual (SM)
Prepared by Joseph Smolira, Belmont University
The Fundamentals Solutions Manual provides detailed solutions to the extensive end-of-chapter
material, including concept review questions, quantitative problems, and cases.
• Test Bank
Prepared by Kay Johnson, Penn State University—Erie
Over 100 questions and problems per chapter! Each chapter is divided into FIVE parts. Part I contains
questions that test the understanding of the key terms in the book. Part II includes questions patterned
after the learning objectives, concept questions, chapter-opening vignettes, boxes, and highlighted
phrases. Part III contains multiple-choice problems patterned after the end-of-chapter questions, in
basic, intermediate, and challenge levels. Part IV provides essay questions to test problem-solving skills
and more advanced understanding of concepts. Part V is a new section that picks up questions
directly from the end-of-chapter material and converts them into parallel test bank questions. For your
reference, each TB question in this part is linked with its corresponding question in the EOC.
• Computerized Test Bank (Windows)
Create your own tests in a snap! These additional questions are found in a computerized test bank
utilizing McGraw-Hill’s EZ Test testing software to quickly create customized exams. This user-friendly
program allows instructors to sort questions by format; edit existing questions or add new ones; and
scramble questions for multiple versions of the same test.
• PowerPoint Presentations
Prepared by Steve Dolvin, Butler University
The PowerPoint slides for the ninth edition have been revised to include a wealth of instructor material, including lecture tips, real world examples, and international notes. Each presentation now also
includes slides dedicated entirely to ethics notes that relate to the chapter topics. In addition, the
PPTs provide exhibits and examples both from the book and from outside sources. Applicable slides

have Web links that take you directly to specific Internet sites, or a spreadsheet link to show an
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example in Excel. Go to the Notes Page function for more tips and information while presenting the slides to your class.
Customize our content for your course! If you already have PowerPoint installed on
your PC, you have the ability to add, delete, edit, print, or rearrange the complete presentation to focus on your course needs.

Videos (DVD Format)
Current set of videos on hot topics! McGraw-Hill/Irwin produced a series of finance videos that
are 10-minute case studies on topics such as Financial Markets, Careers, Rightsizing, Capital
Budgeting, EVA (Economic Value Added), Mergers and Acquisitions, and International Finance.

ONLINE SUPPORT
Online learning center at www.mhhe.com/rwj
The Online Learning Center (OLC) contains FREE access to additional Web-based study and
teaching aids created for this text, such as:

Student Support
A great resource for those seeking additional practice, students can access self-grading
quizzes, Excel template problems, electronic flashcards, and the brand new program,
Excel Master, designed by Brad Jordan and Joe Smolira.
• Premium Content Access
iPod Content—The library isn’t the only place to study! Students lead active and
mobile lives. Harness the power of one of the most popular technology tools today and
study on the go. Our innovative approach allows you to download Narrated PowerPoints

and quizzes right into your iPod or other MP3 player device.
Narrated PowerPoint Slides—Created by Kent Ragan, Missouri State University. The
narrated PowerPoints provide real-world examples accompanied by step by step instructions
and explanations for solving problems presented in the chapter. The Concept Checks from the
text are also integrated into the slides to reinforce the key topics in the chapter. Designed specifically to appeal to the different learning methods of students, the slides provide a visual and
audio explanation of topics and problems. Click on the slide and listen to the accompanying
narration! You can view this slides via computer or download them onto your video iPod.

Teaching Support
Along with having access to all of the same material your students can view on the book’s
OLC, you also have password protected access to the Instructor’s Manual, solutions to
end-of-chapter problems and cases, Instructor’s PowerPoint, Excel Template Solutions,
Video clips and Video projects and questions.
WebCT and Blackboard course cartridges allow instructors to manage their course
and administer examinations online. Increase ease, organization, and efficiency and ask
your representative for more details about course cartridges today!

McGraw-Hill Investments Trader
Students receive free access to this Web-based portfolio simulation with a hypothetical
$100,000 brokerage account to buy and sell stocks and mutual funds. Students can use
the real data found at this site in conjunction with the chapters on investments. They can
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also compete against students around the United States. This site is powered by StockTrak, the leading provider of investment simulation services to the academic community.


McGraw-Hill’s Homework Manager and Homework Manager Plus
Are you looking for a way to spend less time grading and to have more flexibility with the problems you assign as homework and tests? McGraw-Hill’s Homework Manager is an exciting
new package option developed for this text! Homework Manager is a Web-based tool for
instructors and students for delivering, answering, and grading end-of-chapter problems and
tests, and providing a limitless supply of self-graded practice for students.
All of the book’s end-of-chapter Questions and Problems are loaded into Homework Manager, and instructors can choose to assign the exact problems as stated in the book, or algorithmic versions of them so each student has a unique set of variables for the problems. You
create the assignments and control parameters such as do you want your students to receive
hints, is this a graded assignment or practice, etc. The test bank is also available in Homework
Manager, giving you the ability to use those questions for online tests. Both the problems and
the tests are automatically graded and the results are stored in a private grade book, which is
created when you set up your class. Detailed results let you see at a glance how each student
does on an assignment or an individual problem—you can even see how many tries it took
them to solve it. If you order this special package, students will receive a Homework Manager
User’s Guide and an access code packaged with their text.
There is also an enhanced version of McGraw-Hill’s Homework Manager through the Homework Manager Plus package option. If you order the text packaged with Homework Manager
Plus, your students will receive Homework Manager as described above, but with an integrated online text included. When students are in Homework Manager and need more help to
solve a problem, there will be a link that takes them to the section of the text online that
explains the concept they are struggling with. All of McGraw-Hill’s media assets, such as videos, narrated lectures, and additional online quizzing, are also integrated at the appropriate
places of the online text to provide students with a full learning experience. If you order this
special package, students will receive the Homework Manager Plus card packaged with their
text, which gives them access to all of these products.
McGraw-Hill’s Homework Manager is powered by Brownstone.

AVAILABLE FOR PURCHASE & PACKAGING
Student Problem Manual ISBN 0077246225
Prepared by Thomas Eyssell, University of Missouri–St. Louis
Need additional reinforcement of the concepts? This valuable resource provides students with
additional problems for practice. Each chapter begins with Concepts for Review, followed by
Chapter Highlights. These re-emphasize the key terms and concepts in the chapter. A short
Concept Test, averaging 10 questions and answers, appears next. Each chapter concludes

with additional problems for the student to review. Answers to these problems appear at the
end of the Student Problem Manual.

BusinessWeek
Your students can subscribe to 15 weeks of BusinessWeek for a special price of $8.25 in addition to the price of the text. Students will receive a pass-code card shrink-wrapped with their
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