Pierre Vernimmen
Corporate
Finance
Theory and Practice
Pascal Quiry
Maurizio Dallocchio
Yann Le Fur
Antonio Salvi

Corporate Finance
This book is unique – one of the ultimate study and reference guides for European financiers from students
to CFOs. The French-language versions of the Vernimmen have been for me some of the most helpful and
trusted companions throughout my professional career.
Dan Arendt, Corporate Finance partner at Deloitte in Luxembourg
This book is particularly useful for those people who look for the bridge between strategic, operational and investment
decisions on one hand, and financial accounts on the other. The authors’ approach, which consists of guiding the reader
from financial accounting to most complex deals that have strategic implications for firms, is new and very useful. I would
recommend this book to those who want to succeed in both the in-house and the external consulting world, as well as in
the area of Corporate Finance.
Stephan Dertnig, Vice President, Moscow Office, The Boston Consulting Group
I’m glad to hear that Vernimmen’s unique book on finance is now available for English-speaking readers. I have known
this excellent book for many years, which all professionals can easily use when they need to go back to the basics of
modern Corporate Finance. Smartly written, thorough, lively, and regularly updated. I strongly recommend it to everyone –
from the debutant in finance to high-level experts. Learning with Vernimmen is a real pleasure.
Antoine Giscard d’Estaing, CFO of Danone
Vernimmen’s Corporate Finance, long overdue in English, is an outstandingly clear and complete manual, a wonderful
merger of practice and theory. Its coverage of the market aspects of Corporate Finance and of European practices
distinguishes its content, but its treatment of all the material makes it essential reading for the student, financier or
industrialist.
Howard Jones, Fellow in Finance at the Saı

¨
d Business School, Oxford University, UK
This book was the first finance book I read as a student in my twenties. I read it again in my thirties to review some of the
key finance challenges I was facing in my professional life. Now, in my forties, I am reviewing it once more to compare the
reality I have to face now in Asia, with the most advanced financial concepts. I have never been disappointed and have
always been able to find the appropriate answer to my questions, as well as food for thought. I am sure my children will
read it when I am in my fifties, as Vernimmen is not just another book on finance: this is finance as a life experiment.
I strongly recommend this book to all the corporate managers facing new questions or challenges in their professional
lives, especially in an international multi-currency context. You do not need to be a finance expert to enjoy reading it, as
it’s really easy to understand, with enough explanations, concrete examples and humour, to help you jump successfully
into the most sophisticated theories. But, if you are an expert, you will also find food for thought, as its methodological
bases are strong enough to satisfy the most demanding CFO.
Jean-Michel Moutin, CFO, Louis Vuitton Asia Pacific-Japan
Understanding Corporate Finance is key to successful company management. From a banker’s point of view, a good
understanding of Corporate Finance is crucial to assist a company. The Vernimmen, written for Europeans by Europeans is
a most useful reference for the student as well as the practitioner. The style of the book is concise, yet every conceivable
aspect of Corporate Finance is covered. Complemented by an exhaustive website containing summaries of key concepts, of
formulae, and of financial statements from a wide range of companies, the Vernimmen is a must.
Michael Rockinger, Professor of Finance, Director of the Institute of Banking and Finance,
HEC & FAME, University of Lausanne, Switzerland
This book efficiently bridges financial theory and practice, and encapsulates everything a Corporate Finance banker will
ever need to know and understand. It is obvious that the authors are passionate about finance, and their enthusiasm is
contagious. Written in an easy and accessible style, this book deserves to become a reference work.
Jan Zarzycki, Director, Equity Capital Markets, Deutsche Bank
Pierre Vernimmen
Corporate
Finance
Theory and Practice
Pascal Quiry
Maurizio Dallocchio

Yann Le Fur
Antonio Salvi
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´
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(sixth edition 2005).
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ISBN-13 978-0-470-09225-5 (PB)
ISBN-10 0-470-09225-4 (PB)
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About the authors
Pascal Quiry is an adjunct finance teacher in the leading French business school
HEC Paris, and a managing director at BNP Paribas Corporate Finance,
specialising in M&A transactions for listed companies.
Maurizio Dallocchio is the current Dean of the leading Italian business school
Bocconi (Milan) and Lehman Brothers Chair of Corporate Finance. He is also a
board member of several listed and unlisted companies and is one of the most
distinguished Italian authorities on finance.
Yann Le Fur is a corporate finance teacher at HEC Paris business school and an
investment banker with Mediobanca in Paris (after several years with Schroders
and Citigroup).
Antonio Salvi is an Assistant Professor of Finance at Bocconi and the University of
Venice wher e he teaches Corporate Finance. His areas of research cover cost of
capital, structure of debt finance and corporate governance.
Pierre Vernimmen, who died in 1996, was both an M&A dealmaker (he advised
Louis Vuitton on its merger with Mo e

¨
t Henessy to create LVMH, the world luxury
goods leader) and a finance teacher at HEC Paris. His book, Finance d’Entreprise,
was and still is the top-selling financial textbook in French-speaking countries and
is the forebear of Corporate Finance: Theory and Practice.
The authors of this book wish to express their profound thanks to the HEC
Paris Business School and Foundation, ABN Amro, Barclays, BNP Paribas,
DGPA, HSBC, Lazard, and Nomura for their generous financial support; also
Matthew Cush, Robert Killingsworth, John Olds, Gita Roux, Steven Sklar and
Patrice Carlean-Jones who helped us tremendously in writing this b ook.
Summary
Foreword by Richard Roll xvi
Preface xviii
List of frequently used symbols xxii
1 What is corporate finance? 1
Section I
Financial analysis
15
Part One
Fundamental concepts in
financial analysis
17
2 Cash flows 19
3 Earnings 29
4 Capital employed and invested
capital
44
5 Walking through from earnings to
cash flow
57

6 Getting to grips with consolidated
accounts
73
7 How to cop e with the most complex
points in financial accounts
94
Part Two
Financial analysis and
forecasting
121
8 How to perform a financial
analysis
123
9 Margin analysis: Structure 155
10 Margin analysis: Risks 178
11 Working capital and capital
expenditures
193
12 Financing 217
13 Return on capital employed and
return on equity
232
14 Conclusion of financial analysis 252
Section II
Investment analysis
259
Part One
Investment decision rules
261
15 The financial markets 263

16 The time value of money and Net
Present Value (NPV)
290
17 The Internal Rate of Return (IRR) 309
18 Incremental cash flows and other
investment criteria
327
19 Measuring value creation 345
20 Risk and investment analysis 367
Part Two
The risk of securities and the
cost of capital
385
21 Risk and return 387
vii
22 The cost of equity 419
23 From the cost of equ ity to the
cost of capital
443
24 The term structure of interest
rates
461
Section III
Corporate financial
policies
473
Part One
Financial securities
475
25 Enterprise value and financial

securities
477
26 Debt securities 485
27 Managing net debt 512
28 Shares 538
29 Options 556
30 Hybrid securities 577
31 Selling securities 601
Part Two
Capital structure policies
635
32 Value and corporate finance 637
33 Capital structure and the theory
of perfect capital markets
657
34 The tradeoff model 668
35 Debt, equity and options theory 698
36 Working out details: The design
of the capita l structure
716
Part Three
Equity capital and dividend
policies
753
37 Internal financing: Reinvesting cash
flow
755
38 Returning cash to shareholders:
Dividend policies
768

39 Capital increases 792
Section IV
Financial management
809
Part One
Valuation and financial
engineering
811
40 Valuation 813
41 Choice of corporate structu re 844
42 Taking control of a company 873
43 Mergers and demergers 894
44 Leveraged buyouts (LBOs) 912
45 Bankruptcy and restructuring 923
Part Two
Managing net debt and
financial risks
937
46 Managing cash flows 939
47 Asset-based financing 956
48 Managing financial risks 972
Glossary 992
Index 1002
Vernimmen.com 1031
Cribsheet 1032
Summary
Contents
Foreword by Richard Roll xvi
Preface xviii
List of frequently used symbols xxii

1 What is corporate finance? 1
1.1 The financial manager is first and foremost a salesman 1
1.2 of financial securities 4
1.3 valued continuously in the financial markets 7
1.4 Most importantly, he is a negotiator 10
1.5 and he remembers to do an occasional reality check! 11
Section I Financial analysis 15
Part One Fundamental concepts in financial analysis 17
2 Cash flows 19
2.1 Operating and investment cycles 20
2.2 Financial resources 22
3 Earnings 29
3.1 Additions to wealth and deductions to wealth 29
3.2 Different income statement formats 34
4 Capital employed and invested capital 44
4.1 The balance sheet: definitions and concepts 45
4.2 The capital-employed analysis of the balance sheet 47
4.3 A solvency-and-liquidity analysis of the balance sheet 51
4.4 A detailed example of a capital-employed balance sheet 53
5 Walking through from earnings to cash flow 57
5.1 Analysis of earnings from a cash flow perspective 57
5.2 Cash flow statement 61
6 Getting to grips with consolidated accounts 73
6.1 Consolidation methods 73
6.2 Consolidation-related issues 80
6.3 Technical aspects of consolidation 85
7 How to cope with the most complex points in financial accounts 94
7.1 Accruals 95
7.2 Construction contracts 95
7.3 Convertible bonds and loans 96

7.4 Currency translation adjustments 97
7.5 Deferred tax assets and liabilities 97
7.6 Dilution profit and losses 99
7.7 Exchangeable bonds 100
7.8 Goodwill 100
7.9 Intangible fixed assets 101
7.10 Inventories 104
7.11 Leases 106
7.12 Mandatory convertible bonds 108
7.13 Off-balance-sheet commitments 108
7.14 Preference shares 110
7.15 Perpetual subordinated loans and notes 111
7.16 Provisions 111
7.17 Stock options 115
7.18 Tangible fixed assets 116
7.19 Treasury shares 117
Part Two Financial analysis and forecasting 121
8 How to perform a financial analysis 123
8.1 What is financial analysis? 123
8.2 Economic analysis of companies 125
8.3 An assessment of a company’s accounting policy 137
8.4 Standard financial analysis plan 138
8.5 The various techniques of financial analysis 139
8.6 Ratings 142
8.7 Scoring techniques 143
8.8 Expert systems 144
9 Margin analysis: Struc ture 155
9.1 How operating profit is formed 156
9.2 How operating profit is allocated 166
9.3 Financial assessment 167

9.4 Pro forma income statements (individual and consolidated accounts) 172
9.5 Case study: Ericsson 172
10 Margin analysis: Risks 178
10.1 How operating leverage works 178
10.2 A more refined analysis provides greater insight 182
10.3 From analysis to forecasting: the concept of normative margin 187
10.4 Case study: Ericsson 188
11 Working capital and capital expenditures 193
11.1 The nature of working capital 193
11.2 Working capital turnover ratios 197
ix
Contents
11.3 Reading between the lines of working capital 201
11.4 Analysing capital expenditures 207
11.5 Case study: Ericsson 210
12 Financing 217
12.1 A dynamic analysis of the company’s financing 218
12.2 A static analysis of the company’s financing 220
12.3 Case study: Ericsson 227
13 Return on capital employed and return on equity 232
13.1 Analysis of corporate profitability 232
13.2 Leverage effect 234
13.3 Uses and limitations of the leverage effect 243
13.4 Case study: Ericsson 246
14 Conclusion of financial analysis 252
14.1 Solvency 252
14.2 Value creation 254
14.3 Financial analysis without the relevant accounting documents 255
14.4 Case study: Ericsson 256
Section II Investment analysis 259

Part One Investment decision rules 261
15 The financial markets 263
15.1 The rise of capital markets 263
15.2 The functions of a financial system 268
15.3 The relationship between banks and companies 270
15.4 From value to price (1): financial communication 271
15.5 From value to price (2): efficient markets 272
15.6 Limitations in the theory of efficient markets 277
15.7 Investors’ behaviour 282
16 The time value of money and Net Present Value (NPV) 290
16.1 Capitalisation 290
16.2 Discounting 294
16.3 Present value and net present value of a financial security 296
16.4 The NPV decision rule 297
16.5 What does net present value depend on? 298
16.6 Some examples of simplification of present value calculations 299
16.7 Special NPV topics 302
17 The Internal Rate of Return (IRR) 309
17.1 How is internal rate of return determined? 309
17.2 Internal rate of return as an investment criterion 310
17.3 The limits of the internal rate of return 310
17.4 Some more financial mathematics: interest rate and yield to maturity 317
x
Contents
18 Incremental cash flows and other investment criteria 327
18.1 The predominance of NPV and the importance of IRR 327
18.2 The main lines of reasoning 329
18.3 Which cash flows are important? 333
18.4 Other investment criteria 334
19 Measuring value cre ation 345

19.1 Accounting criteria 348
19.2 Economic criteria 353
19.3 Market criteria 357
19.4 Putting things into perspective 359
20 Risk and investment analysis 367
20.1 A closer look at risk 368
20.2 The contribution of real options 373
Part Two The risk of securities and the cost of capital 385
21 Risk and return 387
21.1 Sources of risk 387
21.2 Risk and fluctuation in the value of a security 389
21.3 Tools for measuring return and risk 392
21.4 How diversification reduces risk 394
21.5 Portfolio risk 396
21.6 Measuring how individual securities affect portfolio risk:
the beta coefficient 401
21.7 Choosing among several risky assets and the efficient frontier 405
21.8 Choosing between several risky assets and a risk-free asset:
the capital market line 407
21.9 How portfolio management works 411
22 The cost of equity 419
22.1 Return required by investors: the CAPM 420
22.2 Properties of the CAPM 424
22.3 The limits of the CAPM model 425
22.4 Multifactor models 429
22.5 The cost of equity based on historical returns 432
22.6 The cost of equity based on current market prices 434
22.A A formal derivation of the CAPM 440
23 From the cost of equity to th e cost of capital 443
23.1 The cost of capital and the  of assets 443

23.2 Alternative methods for estimating the cost of capital 444
23.3 Some practical applications 450
23.4 Can corporate managers influence the cost of capital? 453
23.5 Cost of capital: a look at the evidence 455
xi
Contents
24 The term structure of interest rates 461
24.1 Fixed income securities and risk 461
24.2 The different interest rate curves 463
24.3 Relationship between interest rates and maturities 466
24.4 The stochastic approach to modelling the rate structure 469
24.5 A flashback 469
Section III Corporate financial policies 473
Part One Financial securities 475
25 Enterprise value and financial securities 477
25.1 A completely different way of looking at things 477
25.2 Debt and equity 478
25.3 Overview of how to compute enterprise value 480
25.4 Valuation by discounting free cash flows 480
26 Debt securities 485
26.1 Basic concepts 487
26.2 The yield to maturity 489
26.3 Floating rate bonds 492
26.4 Other debt securities 495
26.5 The volatility of debt securities 499
26.6 Default risk and the role of rating 503
27 Managing net debt 512
27.1 General features of corporate financing 512
27.2 Marketable debt securities 517
27.3 Bank debt products 520

27.4 Leasing 527
27.5 Project financing 530
27.6 Investment of cash 533
28 Shares 538
28.1 Basic concepts 538
28.2 Price/Earnings ratio 545
28.3 Key market data 548
28.4 Adjusting per-share data for technical factors 550
29 Options 556
29.1 Definition and theoretical foundation of options 557
29.2 Mechanisms used in pricing options 559
29.3 Analysing options 561
29.4 Parameters to value options 564
29.5 Methods for pricing options 566
29.6 Tools for managing an options position 570
xii
Contents
30 Hybrid securities 577
30.1 Warrants 578
30.2 Convertible bonds 582
30.3 Preference shares 588
30.4 Other hybrid securities 591
31 Selling securities 601
31.1 General principles in the sale of securities 601
31.2 Initial public offerings (IPOs) 607
31.3 Capital increases 613
31.4 Block trades of shares 618
31.5 Bonds 620
31.6 Convertible and exchangeable bonds 626
31.7 Syndicated loans 626

Part Two Capital structure policies 635
32 Value and corporate finance 637
32.1 The purpose of finance is to create value 637
32.2 Value creation and markets in equilibrium 640
32.3 Value and organisation theories 644
32.4 How can we create value? 650
32.5 Value and taxation 651
33 Capital structure and the theory of perfect capital markets 657
33.1 The evidence from the real world 658
33.2 The capital structure policy in perfect financial markets 660
34 The tradeoff model 668
34.1 The benefits of debt 669
34.2 The costs of debt 681
34.3 The tradeoff model 687
34A The capital structure choice: the Endesa case 695
35 Debt, equity and options theory 698
35.1 Analysing the firm in light of options theory 699
35.2 Contribution of the options theory to the valuation of equity 701
35.3 Using options theory to analyse a company’s financial decisions 704
35.4 Resolving conflicts between shareholders and creditors 708
36 Working out details: The design of the capital structu re 716
36.1 The major concepts 717
36.2 Competitors, lifecycle and other capital structure determinants 722
36.3 Other factors affecting the capital structure choice 726
36.4 Effects of the financing choice on accounting and financial criteria 729
36.5 Working out the details of the capital structure 733
36.6 Capital structure policies: a look at the evidence 741
36A Capital structure design: the Alitalia case 747
xiii
Contents

Part Three Equity capital and dividend policies 753
37 Internal financing: Reinvesting cash flow 755
37.1 Reinvested cash flow and the value of equity 756
37.2 Internal financing and the various stakeholders 759
37.3 Internal financing and return criteria 760
38 Returning cash to shareholders: Dividend policies 768
38.1 Dividends and market value 768
38.2 Dividend distribution in practice 772
38.3 Share buybacks 778
38.4 Taxation of dividends, share buybacks and capital reduction 783
39 Capital increases 792
39.1 A definition of capital increase 792
39.2 Capital increases and finance theory 794
39.3 Old and new shareholders 796
39.4 Capital increases and financial criteria 799
Section IV Financial management 809
Part One Valuation and financial engineering 811
40 Valuation 813
40.1 Overview of the different methods 813
40.2 Premiums and discounts 814
40.3 Valuation by discounted cash flow 818
40.4 Multiple approach or peer group comparisons 826
40.5 The sum-of-the-parts method and Restated Net Asset Value (RNAV) 832
40.6 Example: valuation of Ericsson 835
40.7 Comparison of valuation methods 837
41 Choice of corporate structure 844
41.1 Shareholder structure 844
41.2 Initial Public Offerings (IPOs) and corporate governance 853
41.3 How to strengthen control over a company 857
41.4 Financial securities’ discounts 865

41.5 Organising a diversified group 867
42 Taking control of a company 873
42.1 The rise of mergers and acquisitions 873
42.2 Choosing a negotiating strategy 877
42.3 Taking over a listed European company 882
43 Mergers and demergers 894
43.1 All-share deals 894
43.2 The mechanics of all-share transactions 899
43.3 Demergers and splitoffs 904
xiv
Contents
44 Leveraged buyouts (LBOs) 912
44.1 LBO structures 912
44.2 The players 915
44.3 LBOs and financial theory 920
45 Bankruptcy and restructuring 923
45.1 Causes of bankruptcy 923
45.2 Bankruptcy and financial theory 928
45.3 An illustrative example of financial restructuring 931
Part Two Managing net debt and financial risks 937
46 Managing cash flows 939
46.1 Basic tenets 939
46.2 Cash management 942
46.3 Cash management within a group 947
46.4 Investment of cash 951
47 Asset-based financing 956
47.1 Reasons for using asset-based financing 956
47.2 Main techniques 958
47.3 Accounting treatment 964
47.4 Consequences for financial analysis 968

48 Managing financial risks 972
48.1 The various sources of financial risk 972
48.2 Measuring financial risks 973
48.3 Principles of financial risk management 975
48.4 Organised markets–OTC markets 985
Glossary 992
Index 1002
Vernimmen.com 1031
Cribsheet 1032
xv
Contents
Foreword by Richard Roll
Thirty years ago, when I lived and worked in Europe, only a handful of financial
scholars resided on that continent and no finance texts had a European focus. How
things have changed! This book is a wonderful example of the progress that has
been made. Pierre Vernimmen became an important catalyst for change when he
published (in French) one of the first European-oriented corporate finance texts in
the 1970s. It is now available in English, updated, expanded and rendered
invaluable not only to students but also to practising financial managers.
The book itself covers all the important techniques that a financial manager
must have in his repertoire of tools. Its scope is breathtaking: from the basics of
financial analysis through accounting, capital markets, risk, arbitrage, portfolio
analysis, options, agency and signalling concepts, to the ultimate goal of corporate
finance, decision making about equity issuance, leverage, mergers, bankruptcy and
other important financial events . The exposition is clear and concise and, most
importantly, relies on commonsense reasoning throughout. This is not a book
with obscure formulae, yet is still rigorous and at the same time a model of clarity.
Two noteworthy attributes of the book are, first, its association with an
excellent website and, second, the commitment of the authors to issue a monthly
newsletter with updated research information about topical issues. In the December

2004 newsletter, for example, we find a tabulation of corporate income tax rates
compared across countries and traced over time. There are also fascinating articles
about form ing a European-wide company, on how joining or leaving an index
affects an individual firm’s stock price and on whether it makes sense for European
firms to list their stock on an American exchange (in general, it doesn’t).
The website is even better. It provides lots of data to those who feel a burning
need to perform a few statistical calculations. It has an extensive glossary and a
comprehensive research bibliography about every important topic in finance.
It even has quizzes to test your financial acumen, cross-referenced against chapters
in Corporate Finance where the answers, given briefly on the Web, are explained in
detail. I enjoyed going through these quizzes even though getting a few wrong
answers was humbli ng.
It seems to me that the European focus of this book is entirely appropriate for
European financial managers and for students who wish to pursue careers in
finance. There are enough international differences in legal systems, accounting
methods and management practices to make a focused text invaluable. Of
course, the basic principals of finance are universal, but examples, case studies,
problem sets and quizzes are much more transparent when they involve a familiar
and realistic setting. In summ ary, if I were teaching corporate finance in Europe or
consulting with a financial team at a European company, I would strongly urge
everyone, from students up through the CFO, to possess this book. It contains the
answers to most questions that financial managers ask every day and, most
importantly, the answers are easy to find.
Richard Roll
Japan Alumni Chair in International Finance at the UCLA Anderson School
xvii
Foreword by Richard Roll
Preface
This book aims to cover the full scope of corporate finance as it is practised today
in Europe.

A way of thinking about finance
There are four key features that distinguish this book from the many other
corporate finance textbooks available on the market today:
. Our strong belief that financial analysis is part of corporate finance. Pierre
Vernimmen, who was the mentor and partner in the practice of corporate
finance of some of us, understood very early on that a good financial manager
must first be able to analyse a company’s economic, financial and strategic
situation, and then value it, while at the same time mastering the conceptual
underpinnings of all financial decisions.
. Corporate Finance is neither a theoretical textbook nor a practical workbook.
It is a book in which theory and practice are constantly set off against each
other, in the same way as we do in our daily practice of corporate finance, as
investment bankers at BNP Paribas, DGPA, Mediobanca, as board members
of several listed and unlisted companies, and as teachers at the Bocconi and
HEC business schools.
. Emphasis is placed on concepts intended to give you an understanding of
situations, rather than on techniques, which tend to shift and change over
time. We confess to believing that the former will still be valid in 20 years
time, whereas the latter will for the most part be long forgotten!
. Financial concepts are internationa l, but they are much easier to grasp when
they are set in a familiar context. Written by Europeans for Europeans,
Corporate Finance explains how finance works on European markets, such
as London, Frankfurt and Madrid.
The four sections
This book starts with an introductory chapter reiterating the idea that corporate
financiers are the bridge between the economy and the realm of finance.
Increasingly, they must play the role of marketing manager and negotiator.
Their products are financial securities that represent rights to the firm’s cash
flows. Their customers are bankers and investors. A good financial manager listens
to customers and sells them good products at high prices. A good financial manager

always thinks in terms of value rather than costs or earnings.
Section I goes over the basics of financial analysis – i.e., understanding the
company based on a detailed analysis of its accounts. We are amazed at the extent
to which large numbers of investors neglected this approach during the latest
stockmarket euphoria. When share prices everywhere are rising, why stick to a
rigorous approach? For one thing, to avoid being caught in the crash that
inevitably follows. How many investors took the trouble to read Enron’s annual
report? Those who did found that it spoke volumes!
We are convinced that a return to reason will also return financial analysis to
its rightful place as a cornerstone of economic decision making. To perform
financial analysis, you must first understand the firm’s basic financial mechanics
(Chapters 2–5), master the basic techniques of accounting, including accounting
principles, consolidation techniques, and certain complexities (Chapters 6–7), based
on international (IAS) standards, now mandatory for listed European companies.
In order to make things easier for the newcomer to finance, we have structured the
presentation of financial analysis itself around its guiding principle: in the long run,
a company can survive only if it is solvent and creates value for its shareholders.
To do so, it must create value (Chapters 9 and 10), invest (Chapter 11), finance
its investments (Chapter 12) and generate a sufficient return (Chapter 13). The
illustrative financial analysis of Ericsson will guide you throughout this section
of the book.
Section II reviews the basic theoretical knowledge you will need to mak e an
assessment of the value of the firm. Here again, the emphasis is on reasoning, which
in many cases will become automatic (Chapters 15–24): efficient capital markets,
the time value of money, the price of risk, volatility, arbitrage, return, portfolio
theory, present value and future value, market risk, beta, etc.
In Section III, ‘‘Corporate financial policies’’, we review the major types of
financial securities: equity, debt and options, for the purposes of valuation, along
with the techniques for issuing and placing them (Chapters 25–31). Then, we
analyse each financial decision in terms of:

. value in the context of the theory of efficient capital markets;
. balance of power between owners and managers, shareholders and debtholders
(agency theory);
. communication (signal theory).
Such decisions include choosing a capital structure, investment decisions, cost of
capital, dividend policy, share repurchases, capital increases, hybrid security issues,
etc.
In the course of this section, we call your attention to today’s obsession with
earnings per share, return on equity and other measures whose underlying basis we
have a tendency to forget an d which may, in some cases, be only distantly related to
value creation. We have devoted considerable space to the use of options (as a
technique or a type of reasoning) in each financial decision (Chapters 32–39).
When you start reading Section IV, ‘‘Financial management’’, you will be
ready to examine and take the remaining decisions: how to organise a company’ s
equity capital, buying and selling companies, mergers, demergers, LBOs, bank-
ruptcy and restructuring (Chapters 40–45). Lastly, this section presents cash flow
xix
Preface
management, asset-based financing and management of the firm’s financial risks
(Chapters 46–48).
Instructions to the reader
To make sure that you get the most out of your book, each chapter ends with a
summary, a series of problems and questions (a total of 746) (solutions provided).
The appendix contains a 75-entry glossary, with a further 1,300 terms defined on
the site www.vernimmen.com. We’ve used the last page of the book to provide a
cribsheet (nearly 1,000 pages of this book summarised on one page!). For those
interested in exploring the topics discussed in greater depth, there is an end-of-
chapter bibli ography giving suggestions for further reading, covering fundamental
research papers, articles in the press and published books. A large number of
graphs and tables (over 100!) have been included in the body of the text which

can be used for comparative analyses. Finally, the index is fully comprehensive.
An Internet site with huge and diversified content
www.vernimmen.com provides free access to tools (formulas, tables, statistics,
lexicons, glossaries), resources that supplement the book (articles, prospectuses
of financial transactions, financial figures for more than 10,000 European and
North American listed companies, thesis topics, thematic links, a list of must-
have books for your bookshelf, an Excel file providing detailed solutions to all
of the problems set in the book), problems, case studies, quizzes for testing and
improving your knowledge. There is a letterbox for your questions to the authors
(we aim to reply within 72 hours, unless of course you manage to stump us!). There
are questions and answers and much more. New services are put onto the site,
which has its own internal search engine, on a regular basis.
A free monthly newsletter on corporate finance
Since (unfortunately) we can’t bring out a new edition of the Vernimmen every
month, we have set up the Vernimmen.com Newsletter, which is sent out free of
charge to subscribers by means of the Internet. It contains:
. A conceptual look at a topical corporat e finance problem (e.g., the European
company: a new tool to facilitate cross-border mergers, EU anti-concentration
regulations, the value of synergies).
. Statistics or table s that you are likely to find useful in the day-to-day practice
of corporate finance (e.g., worldwide corporate income tax rates, yield curves,
IPOs since 1987).
. A critical review of a financial research paper with a concret e dimension (e.g.,
conglomerates and diversification, new ideas on financial structure, leasing vs.
bank loans).
xx
Preface
. A question left on the vernimmen.com site by a visitor plus a response
(e.g., What are the advantages and drawbacks of spinning off a division? Does
writedown of goodwill impact on values? What is dilution? )

Subscribe on www.vernimmen.com and become one of the many readers of the
Vernimmen.com Newsletter.
Many thanks
. To Eric Briys, Didier Kunstlinger and Renaud Lefebvre for their seminal,
friendly and effici ent support.
. To Richard Roll for the many kind words included in the foreword.
. To Sebastian Cardarelli, Benoıˆ t de Courcelles, Evgueni Madorski, Ryan
McGovern, and the other students of HEC and Bocconi MBA programmes
for their help in improving the manuscript.
. To Vincent Jacques, the vernimmen.com webmaster.
. To Isabelle Marie
´
-Sall for her help in transforming our scribblings into a
proper manuscript.
. And last but not least to our relatives and our many friends who have had to
endure our endless absences over the last two and a half years, and of course
Catherine Vernimmen and her children for their everlasting and kind support.
We hope that you will gain as much enjoyment from your Vernimmen, whether you
are a new student of corporate finance or whether you are using it to revise and
hone your financial skills, as we have had in editing this edition and in expanding
the services and products that go with the book.
We wish you well in your studies!
Milan and Paris, May 2005
Pascal Quiry Maurizio Dallocchi o
Yann Le Fur Antonio Salvi
xxi
Preface
Frequently used symbols
A
N

k
Annuity factor for N years and an interest rate of k
ABCP Asset Backed Commercial Paper
ACES Advanced Computerised Execution System
ADR American Depositary Receipt
APT Arbitrage Pricing Theory
APV Adjusted Present Value
ARR Accounting Rate of Return
BIMBO Buy In Management Buy Out
BV Book Value
Capex Capital Expenditures
CAPM Capital Asset Pricing Model
CAR Cumulative Abnormal Return
CB Convertible Bond
CD Certificate of Deposit
CDO Collateralised Debt Obligation
CE Capital Employed
CFROI Cash Flow Return On Investment
COV Covariance
CVR Contingent Value Right
D Debt, net financial and banking debt
d Payout ratio
DCF Discounted Cash Flows
DDM Dividend Discount Model
DECS Debt Exchangeable for Common Stock; Dividend Enhanced Convertible Securities
DFL Degree of Financial Leverage
Div Dividend
DJ Dow Jones
DOL Degree of Operating Leverage
DPS Dividend Per Share

DR Depositary Receipt
EAT Earnings After Tax
EBIT Earnings Before Interest and Taxes
EBITDA Earnings Before Interest, Taxes, Depreciation and Amortisation
EBRD European Bank for Reconstruction and Development
ECAI External Credit Assessment Institution
ECP European Commercial Paper
EGM Extraordinary General Meeting
EMTN European Medium Term Note
ENPV Expanded Net Present Value
EONIA European Over Night Index Average
EPS Earnings Per Share
EðrÞ Expected return
ESOP Employee Stock Ownership Programme
EURIBOR EURopean Inter Bank Offer Rate
EV Enterprise Value