If a firm increases its plowback ratio, this will probably result in _______ p/e ratio.

Essentials of Corporate Finance

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The McGraw-Hill Education Series in Finance, Insurance, and Real Estate

FINANCIAL MANAGEMENT Block, Hirt, and Danielsen Foundations of Financial Management Seventeenth Edition

Brealey, Myers, and Allen Principles of Corporate Finance Thirteenth Edition

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Brealey, Myers, and Marcus Fundamentals of Corporate Finance Tenth Edition

Brooks FinGame Online 5.0

Bruner, Eades, and Schill Case Studies in Finance: Managing for Corporate Value Creation Eighth Edition

Cornett, Adair, and Nofsinger Finance: Applications and Theory Fifth Edition

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DeMello Cases in Finance Third Edition

Grinblatt (editor) Stephen A. Ross, Mentor: Influence through Generations Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition

Higgins Analysis for Financial Management Twelfth Edition

Ross, Westerfield, Jaffe, and Jordan Corporate Finance Twelfth Edition

Ross, Westerfield, Jaffe, and Jordan Corporate Finance: Core Principles and Applications Fifth Edition

Ross, Westerfield, and Jordan Essentials of Corporate Finance Tenth Edition

Ross, Westerfield, and Jordan Fundamentals of Corporate Finance Twelfth Edition

Shefrin Behavioral Corporate Finance: Decisions that Create Value Second Edition

INVESTMENTS Bodie, Kane, and Marcus Essentials of Investments Eleventh Edition

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Stephen A. Ross

Randolph W. Westerfield University of Southern California

Bradford D. Jordan University of Kentucky

Essentials of Corporate Finance

Tenth Edition

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ESSENTIALS OF CORPORATE FINANCE, TENTH EDITION

Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2020 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2017, 2014, and 2011. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.

Some ancillaries, including electronic and print components, may not be available to customers outside the United States.

This book is printed on acid-free paper.

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ISBN 978-1-260-01395-5 MHID 1-260-01395-2

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All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.

Library of Congress Cataloging-in-Publication Data

Ross, Stephen A., author. | Westerfield, Randolph W., author. |  Jordan, Bradford D., author.  Essentials of corporate finance / Stephen A. Ross, Massachusetts  Institute of Technology, Randolph W. Westerfield, University of Southern  California, Bradford D. Jordan, University of Kentucky.  Tenth edition. | New York, NY : McGraw-Hill Education, [2020] |  Includes index.  LCCN 2018056010 | ISBN 9781260013955 (student edition : alk. paper)  LCSH: Corporations—Finance.  LCC HG4026 .R676 2020 | DDC 658.15—dc23  LC record available at https://lccn.loc.gov/2018056010

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 Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.

mheducation.com/highered

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About the Authors

Stephen A. Ross

Stephen A. Ross was 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 was widely recognized for his work in develop- ing 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 also served as an associate editor of several academic and practitioner journals. He was a trustee of CalTech. He died suddenly in March 2017.

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 Emeritus. Professor West- erfield came to USC from the Wharton School, University of Pennsylvania, where he was the chair- man of the finance department and member of the finance faculty for 20 years. He is a member of the Board of Trustees of Oak Tree Capital Mutual Funds. 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 duPont Endowed Chair in Banking and Financial Services. 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 finan- cial 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 is coauthor of Fundamentals of Investments: Valuation and Management, 8th edition, a leading investments text, also published by McGraw-Hill Education.

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From the Authors

W hen we first wrote Essentials of Corporate Finance, we thought there might be a small niche for a briefer book that really focused on what students with widely varying backgrounds and interests needed to carry away from an introductory finance course. We were wrong. There was a huge niche! What we learned is that our text closely matches the needs of instructors and faculty at hundreds of schools across the country. As a result, the growth we have experienced through the first nine editions of Essentials has far exceeded anything we thought possible.

With the tenth edition of Essentials of Corporate Finance, we have continued to refine our focus on our target audience, which is the undergraduate student taking a core course in busi- ness or corporate finance. This can be a tough course to teach. One reason is that the class is usually required of all business students, so it is not uncommon for a majority of the students to be nonfinance majors. In fact, this may be the only finance course many of them will ever have. With this in mind, our goal in Essentials is to convey the most important concepts and principles at a level that is approachable for the widest possible audience.

To achieve our goal, we have worked to distill the subject down to its bare essentials (hence, the name of this book), while retaining a decidedly modern approach to finance. We always have maintained that the subject of corporate finance can be viewed as the workings of a few very powerful intuitions. We also think that understanding the “why” is just as important, if not more so, than understanding the “how”—especially in an introductory course. Based on the gratifying market feedback we have received from our previous editions, as well as from our other text, Fundamentals of Corporate Finance (now in its twelfth edition), many of you agree.

By design, this book is not encyclopedic. As the table of contents indicates, we have a total of 18 chapters. Chapter length is about 30 pages, so the text is aimed squarely at a single-term course, and most of the book can be realistically covered in a typical semester or quarter. Writ- ing a book for a one-term course necessarily means some picking and choosing, with regard to both topics and depth of coverage. Throughout, we strike a balance by introducing and covering the essentials (there’s that word again!) while leaving some more specialized topics to follow-up courses.

The other things we always have stressed, and have continued to improve with this edition, are readability and pedagogy. Essentials is written in a relaxed, conversational style that invites the students to join in the learning process rather than being a passive information absorber. We have found that this approach dramatically increases students’ willingness to read and learn on their own. Between larger and larger class sizes and the ever-growing demands on faculty time, we think this is an essential (!) feature for a text in an introductory course.

Throughout the development of this book, we have continued to take a hard look at what is truly relevant and useful. In doing so, we have worked to 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 emerge as our central focus in writing Essentials of Corporate Finance:

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An Emphasis on Intuition We always try to separate and explain the principles at work on a commonsense, 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 finan- cial analysis is made explicit, possible pitfalls are described, and limitations are discussed.

Today, as we prepare once again to enter the market, our goal is to stick with and build on the principles that have brought us this far. However, based on an enormous amount of feed- back 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 and pedagogy by pro- viding a wide variety of features in the book to help students 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 just the textbook, or the book in conjunction with other products, we believe you will find a combination with this edition that will meet your needs.

Randolph W. Westerfield Bradford D. Jordan

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Organization of the Text

W e designed Essentials of Corporate Finance to be as flexible and modular as possible. There are a total of nine parts, and, in broad terms, the instructor is free to decide the particular sequence. Further, within each part, the first chapter generally contains an over- view and survey. Thus, when time is limited, subsequent chapters can be omitted. Finally, the sections placed early in each chapter are generally the most important, and later sections frequently can be omitted without loss of continuity. For these reasons, the instructor has great control over the topics covered, the sequence in which they are covered, and the depth of coverage.

Just to get an idea of the breadth of coverage in the tenth edition of Essentials, the fol- lowing grid presents for each chapter some of the most significant new features, as well as a few selected chapter highlights. Of course, in every chapter, figures, opening vignettes, boxed features, and in-chapter illustrations and examples using real companies have been thoroughly updated as well. In addition, the end-of-chapter material has been completely revised.

Chapters Selected Topics Benefits to Users

PART ONE Overview of Financial Management

Chapter 1 New opener discussing Uber

Updated Finance Matters box on corporate ethics

Describes ethical issues in the context of mortgage fraud, offshoring, and tax havens.

Updated information on executive and celebrity compensation

Highlights important developments regarding the very current question of appropriate executive compensation.

Updated Work the Web box on stock quotes

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.

New proxy fight example involving Trian Partners and Procter & Gamble

New takeover battle discussion involving Verizon and Yahoo!

PART TWO Understanding Financial Statements and Cash Flow

Chapter 2 New opener discussing the Tax Cuts and Jobs Act of 2017 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. New discussion of corporate taxes in light of the TCJA

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Chapters Selected Topics Benefits to Users

Chapter 3 Additional explanation of alternative formulas for sustainable and internal growth rates

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

Updated opener on PE ratios Updated examples on Amazon vs. Alibaba Updated Work the Web box on financial ratios

Discusses how to find and analyze profitability ratios.

Updated Finance Matters box on financial ratios

Describes how to interpret ratios.

PART THREE Valuation of Future Cash Flows

Chapter 4 First of two chapters on time value of money

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

Updated Finance Matters box on collectibles

Chapter 5 Second of two chapters on time value of money

Covers more advanced time value topics with numerous examples, calculator tips, and Excel spreadsheet exhibits. Contains many real-world examples.

Updated opener on professional athletes’ salaries

Provides a real-world example of why it’s important to properly understand how to value costs incurred today versus future cash inflows.

Updated Finance Matters box on lotteries

Updated Finance Matters box on student loans

PART FOUR Valuing Stocks and Bonds

Chapter 6 New opener on negative interest on various sovereign bonds

Discusses the importance of interest rates and how they relate to bonds.

Bond valuation Thorough coverage of bond price/yield concepts. Updated bond features example using Sprint issue Interest rates and inflation Highly intuitive discussion of inflation, the Fisher effect, and

the term structure of interest rates. Updated “fallen angels” example using Teva Pharmaceuticals issue “Clean” vs. “dirty” bond prices and accrued interest

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