Financial Discussion Question

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Principles of
Corporate Finance

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Financial Management

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

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

Brealey, Myers, and Allen
Principles of Corporate Finance, Concise
Second Edition

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

Brooks
FinGame Online 5.0

Bruner
Case Studies in Finance: Managing for
Corporate Value Creation
Eighth Edition

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

Cornett, Adair, and Nofsinger
M: Finance
Fourth Edition

DeMello
Cases in Finance
Second 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
Ninth Edition

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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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Investments
Eleventh Edition

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Fundamentals of Investment Management
Tenth Edition

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Fundamentals of Investments: Valuation
and Management
Eighth Edition

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Running Money: Professional Portfolio
Management

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Derivatives: Principles and Practice
Second Edition

Financial Institutions and
Markets

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Tenth Edition

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Financial Institutions and Markets
Eleventh Edition

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Financial Institutions Management: A Risk
Management Approach
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and Mahoney
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and Other Deferred Compensation
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Future
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THE MCGRAW-HILL/IRWIN SERIES IN FINANCE, INSURANCE, AND REAL ESTATE

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Richard A. Brealey
Professor of Finance

London Business School

Stewart C. Myers
Professor of Financial Economics

Sloan School of Management Massachusetts

Institute of Technology

Franklin Allen
Professor of Finance and Economics

Imperial College London

THIRTEENTH EDITION

Principles of
Corporate Finance

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PRINCIPLES OF CORPORATE FINANCE, THIRTEENTH 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.

1 2 3 4 5 6 7 8 9 0 LWI/LWI 22 21 20 19

ISBN 978-1-260-01390-0
MHID 1-260-01390-1

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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

Names: Brealey, Richard A., author. | Myers, Stewart C., author. | Allen,
Franklin, 1956- author.
Title: Principles of corporate finance / Richard A. Brealey, Professor of
Finance, London Business School, Stewart C. Myers, Robert C. Merton (1970)
Professor of Finance, Sloan School of Management, Massachusetts Institute
of Technology, Franklin Allen, Professor of Finance and Economics,
Imperial College London.
Description: Thirteenth edition. | New York, NY : McGraw-Hill Education, [2020] Identifiers: LCCN 2018040697 | ISBN 9781260013900 (alk. paper)
Subjects: LCSH: Corporations—Finance.
Classification: LCC HG4026 .B667 2020 | DDC 658.15—dc23
LC record available at https://lccn.loc.gov/2018040697

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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To our parents.

Dedication

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⟩ Richard A. Brealey

Professor of Finance at the London
Business School. He is the former
president of the European Finance
Association and a former director
of the American Finance Associa-
tion. He is a fellow of the British
Academy and has served as a spe-
cial adviser to the Governor of the
Bank of England and director of
a number of financial institutions.
Books written by Professor Brealey
include Introduction to Risk and
Return from Common Stocks.

⟩ Stewart C. Myers

Professor of Financial Economics
at MIT’s Sloan School of Manage-
ment. He is past president of the
American Finance Association, a
research associate at the National
Bureau of Economic Research, a
principal of the Brattle Group Inc.,
and a retired director of Entergy
Corporation. His research is pri-
marily concerned with the valuation
of real and financial assets, corpo-
rate financial policy, and financial
aspects of government regulation
of business. He is the author of
influential research papers on many
topics, including adjusted present
value, rate of return regulation,
pricing and capital allocation in
insurance, real options, and moral
hazard and information issues in
capital structure decisions.

⟩ Franklin Allen

Professor of Finance and Econom-
ics, Imperial College London, and
Emeritus Nippon Life Professor of
Finance at the Wharton School of
the University of Pennsylvania. He
is past president of the American
Finance Association, Western
Finance Association, Society
for Financial Studies, Financial
Intermediation Research Society,
Financial Management Association,
and a fellow of the Econometric
Society and the British Academy.
His research has focused on finan-
cial innovation, asset price bubbles,
comparing financial systems, and
financial crises. He is Director
of the Brevan Howard Centre for
Financial Analysis at Imperial
College Business School.

About the Authors

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Preface

⟩
This book describes the theory and practice of corpo-
rate finance. We hardly need to explain why financial

managers have to master the practical aspects of their
job, but we should spell out why down-to-earth manag-
ers need to bother with theory.

Managers learn from experience how to cope with
routine problems. But the best managers are also able to
respond to change. To do so you need more than time-
honored rules of thumb; you must understand why com-
panies and financial markets behave the way they do. In
other words, you need a theory of finance.

Does that sound intimidating? It shouldn’t. Good
theory helps you to grasp what is going on in the world
around you. It helps you to ask the right questions when
times change and new problems need to be analyzed.
It also tells you which things you do not need to worry
about. Throughout this book, we show how managers
use financial theory to solve practical problems.

Of course, the theory presented in this book is not per-
fect and complete—no theory is. There are some famous
controversies where financial economists cannot agree.
We have not glossed over these disagreements. We set out
the arguments for each side and tell you where we stand.

Much of this book is concerned with understanding
what financial managers do and why. But we also say
what financial managers should do to increase company
value. Where theory suggests that financial managers
are making mistakes, we say so, while admitting that
there may be hidden reasons for their actions. In brief,
we have tried to be fair but to pull no punches.

This book may be your first view of the world of
modern finance. If so, you will read first for new ideas,
for an understanding of how finance theory translates
into practice, and occasionally, we hope, for entertain-
ment. But eventually you will be in a position to make
financial decisions, not just study them. At that point,
you can turn to this book as a reference and guide.

⟩ Changes in the Thirteenth Edition
We are proud of the success of previous editions of
Principles, and we have done our best to make the thir-
teenth edition even better.

Some of the biggest changes in this edition were
prompted by the tax changes enacted in the U.S. Tax

Cuts and Jobs Act passed in December 2017. One of
the chapters most affected was Chapter 6, which is con-
cerned with calculating the present value of capital proj-
ects. We describe the major tax changes in that chapter,
and we work through an example of a capital budget-
ing problem with 100% bonus depreciation and a 21%
corporate tax rate. But the U.S. system of immediate
expensing of capital expenditures is almost unique. So
we also set out examples of the more common systems of
straight-line depreciation and double- declining-balance,
which is essentially identical to the former U.S. MACRS
depreciation.

Another 2017 tax change was the limit imposed on
interest tax shields. For companies that are caught by this
change, it may no longer make sense to discount cash
flows by the weighted average cost of capital. We discuss
the implications for company debt policy in Chapter 18.
In Chapter 19, we show how adjusted present value can
be used in these cases to value companies and projects.
Similarly, the cap on interest tax shields complicates the
valuation of leases. In Chapter 25, we show that when the
cap is operative, leases need to be valued by constructing
an equivalent loan. Finally, in Chapter 32, we consider
the possible effect on the private-equity market.

The third important change was the switch by the
United States to a territorial tax system. This has major
implications for tax strategies, which we largely dis-
cuss in the chapters on working capital management
( Chapter 30) and mergers (Chapter 31).

U.S. financial managers work in a global environment
and need to understand the financial systems of other
countries. Also, many of the text’s readers come from
countries other than the United States. Therefore, in recent
editions we have progressively introduced more interna-
tional material, including information about the major
developing economies, such as China and India. In the
current edition, we have continued to augment the interna-
tional content. We hope that an understanding of practices
in other countries will also lead to a better understanding
of the characteristics of one’s own financial system.

Users of previous editions of this book will not find
dramatic changes in coverage or in the ordering of top-
ics. However, there are a number of chapters that have
been thoroughly rewritten. For example, the material
on agency issues in Chapter 12 has been substantially
revised. Chapter 13 on market efficiency and behavioral

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finance is now fresher and more up to date. Chapter 23
on credit risk focuses more on the practical issues of
forecasting default probabilities.

Throughout, we have tried to make the book more
up-to-date and easier to read. In many cases, the changes
consist of some updated data here and a new example
there. Often, these additions reflect some recent devel-
opment in the financial markets or company practice.

In the 11th edition, we added digital extensions through
our Beyond the Page features, or “apps” as we call them.
This extra material can allow us to escape from some of
the constraints of the printed page by providing more
explanation for readers who need it and additional mate-
rial for those who would like to dig deeper. The Beyond
the Page features include extra examples and spreadsheet
programs, as well as some interesting anecdotes.

There are now more than 150 of these apps. They are
all seamlessly available with a click on the e-versions
of the book, but they are also readily accessible from
the traditional hard copy of the text through the shortcut
URLs. Check out mhhe.com/brealey13e to learn more.

Examples of these applications include:

∙ Chapter 1  In Chapter 1, we refer to Bernard
Madoff’s ponzi scheme. But this scam pales into
insignificance compared with the great Albanian
ponzi scheme, which is described in an app.

∙ Chapter 2 Do you need to learn how to use a finan-
cial calculator? The Beyond the Page financial cal-
culator application shows how to do so.

∙ Chapter 3 Would you like to calculate a bond’s dura-
tion, see how it predicts the effect of small interest rate
changes on bond price, calculate the duration of a com-
mon stock, or learn how to measure convexity? The
duration application for Figure 3.2 allows you to do so.

∙ Chapter 5 Want more practice in valuing annuities?
There is an application that provides worked exam-
ples and hands-on practice.

∙ Chapter 9  How about measuring the betas of the
Fama–French three-factor model for U.S. stocks? The
Beyond the Page beta estimation application does this.

∙ Chapter 14 Ever wonder why Google split its stock
into A and C shares? An app provides the answer.

∙ Chapter 15  Want to now how companies can raise
capital by an initial coin offering?  There is an app
on the topic.

∙ Chapter 19  The text briefly describes the flow-to-
equity method for valuing businesses, but using the
method can be tricky. We provide an application that
guides you step by step.

∙ Chapter 20  The Black–Scholes Beyond the Page
application provides an option calculator. It also shows

how to estimate the option’s sensitivity to changes in
the inputs and how to measure an option’s risk.

∙ Chapter 28 Would you like to view the most recent
financial statements for different U.S. companies
and calculate their financial ratios? There is an appli-
cation that will do this for you.

We believe that the apps offer an opportunity to widen
the types of material that can be made available and
help the reader to decide how deeply he or she wishes
to explore a topic.

We have added end-of-chapter questions, merged
what was becoming a false distinction between basic
and intermediate questions, and reordered the questions
to follow better the same sequence as the chapter.

⟩ Making Learning Easier
Each chapter of the book includes an introductory pre-
view, a summary, and an annotated list of suggested
further reading. The list of possible candidates for fur-
ther reading is now voluminous. Rather than trying to
include every important article, we largely list survey
articles or general books. We give more specific refer-
ences in footnotes.

Each chapter is followed by a set of problems on both
numerical and conceptual topics and a few challenge
problems. Answers to the starred problems appear in
the Appendix at the end of the book.

We included a Finance on the Web section in chap-
ters where it makes sense to do so. This section now
houses a number of Web Projects, along with new Data
Analysis problems. These exercises seek to familiar-
ize the reader with some useful websites and to explain
how to download and process data from the web.

The book also contains 13 end-of-chapter Mini-
Cases. These include specific questions to guide the
case analyses. Answers to the mini-cases are available
to instructors on the book’s website.

Spreadsheet programs such as Excel are tailor-
made for many financial calculations. Several chapters
include boxes that introduce the most useful financial
functions and provide some short practice questions.
We show how to use the Excel function key to locate
the function and then enter the data. We think that this
approach is much simpler than trying to remember the
formula for each function.

We conclude the book with a glossary of financial
terms.

The 34 chapters in this book are divided into 11
parts. Parts 1, 2, and 3 cover valuation and capital invest-
ment decisions, including portfolio theory, asset pricing

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models, and the cost of capital. Parts 4 through 8 cover
payout policy, capital structure, options (including real
options), corporate debt, and risk management. Part 9
covers financial analysis, planning, and working-capital
management. Part 10 covers mergers and acquisitions,
corporate restructuring, and corporate governance around
the world. Part 11 concludes.

We realize that instructors will wish to select topics
and may prefer a different sequence. We have therefore
written chapters so that topics can be introduced in several
logical orders. For example, there should be no difficulty
in reading the chapters on financial analysis and planning
before the chapters on valuation and capital investment.

⟩ Acknowledgments
We have a long list of people to thank for their helpful
criticism of earlier editions and for assistance in prepar-
ing this one. They include Faiza Arshad, Aleijda de Caze-
nove Balsan, Kedran Garrison, Robert Pindyck, Donna
Cheung, and Gretchen Slemmons at MIT; Elroy Dim-
son, Paul Marsh, Mike Staunton, and Stefania Uccheddu
at London Business School; Lynda Borucki, Marjorie
Fischer, Larry Kolbe, Michael Vilbert, Bente Villadsen,
and Fiona Wang at The Brattle Group Inc.; Alex Triantis
at the University of Maryland; Adam Kolasinski at Texas
A&M University; Simon Gervais at Duke University;
Michael Chui at Bank for International Settlements; Pedro
Matos at the University of Southern California; Yupana
Wiwattanakantang at National University of Singapore;
Nickolay Gantchev at the Southern Methodist University;
Tina Horowitz, and Lin Shen, at the University of Penn-
sylvania; Darien Huang at Tudor Investment; Julie Wulf
at Harvard University; Jinghua Yan at SAC Capital; Ben-
nett Stewart at EVA Dimensions; and Mobeen Iqbal and
Antoine Uettwiller at Imperial College London. We are
grateful to Cyrus Brealey for his suggestions.

We would also like to thank the dedicated experts
who have helped with updates to the instructor mate-
rials and online content in Connect and LearnSmart,
including Kay Johnson, Blaise Roncagli, Deb Bauer,
Mishal Rawaf, Marc-Anthony Isaacs, Frank Ryan, Peter
Crabb, Victoria Mahan, Nicholas Racculia, Angela
Treinen, and Kent Ragan.

We want to express our appreciation to those instruc-
tors whose insightful comments and suggestions were
invaluable to us during the revision process:

Ibrahim Affaneh Indiana University of Pennsylvania
Neyaz Ahmed University of Maryland
Alexander Amati Rutgers University, New Brunswick
Anne Anderson Lehigh University
Noyan Arsen Koc University

Anders Axvarn Gothenburg University
John Banko University of Florida, Gainesville
Michael Barry Boston College
Jan Bartholdy ASB, Denmark
Penny Belk Loughborough University
Omar Benkato Ball State University
Eric Benrud University of Baltimore
Ronald Benson University of Maryland, University College
Peter Berman University of New Haven
Tom Boulton Miami University of Ohio
Edward Boyer Temple University
Alon Brav Duke University
Jean Canil University of Adelaide
Robert Carlson Bethany College
Chuck Chahyadi Eastern Illinois University
Fan Chen University of Mississippi
Celtin Ciner University of North Carolina, Wilmington
John Cooney Texas Tech University
Charles Cuny Washington University, St. Louis
John Davenport Regent University
Ray DeGennaro University of Tennessee, Knoxville
Adri DeRidder Gotland University
William Dimovski Deakin University, Melbourne
David Ding Nanyang Technological University
Robert Duvic University of Texas at Austin
Alex Edmans London Business School
Susan Edwards Grand Valley State University
Riza Emekter Robert Morris University
Robert Everett Johns Hopkins University
Dave Fehr Southern New Hampshire University
Donald Flagg University of Tampa
Frank Flanegin Robert Morris University
Zsuzanna Fluck Michigan State University
Connel Fullenkamp Duke University
Mark Garmaise University of California, Los Angeles
Sharon Garrison University of Arizona
Christopher Geczy University of Pennsylvania
George Geis University of Virginia
Stuart Gillan University of Delaware
Felix Goltz Edhec Business School
Ning Gong Melbourne Business School
Levon Goukasian Pepperdine University
Gary Gray Pennsylvania State University
C. J. Green Loughborough University
Mark Griffiths Thunderbird, American School of
International Management
Re-Jin Guo University of Illinois, Chicago
Ann Hackert Idaho State University
Winfried Hallerbach Erasmus University, Rotterdam
Milton Harris University of Chicago
Mary Hartman Bentley College
Glenn Henderson University of Cincinnati
Donna Hitscherich Columbia University
Ronald Hoffmeister Arizona State University
James Howard University of Maryland, College Park
George Jabbour George Washington University

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Ravi Jagannathan Northwestern University
Abu Jalal Suffolk University
Nancy Jay Mercer University
Thadavillil (Nathan) Jithendranathan University of Saint
Thomas
Kathleen Kahle University of Arizona
Jarl Kallberg NYU, Stern School of Business
Ron Kaniel University of Rochester
Steve Kaplan University of Chicago
Eric Kelley University of Arizona
Arif Khurshed Manchester Business School
Ken Kim University of Wisconsin, Milwaukee
Jiro Eduoard Kondo Northwestern University Kellogg
School of Management
C. R. Krishnaswamy Western Michigan University
George Kutner Marquette University
Dirk Laschanzky University of Iowa
Scott Lee Texas A&M University
Bob Lightner San Diego Christian College
David Lins University of Illinois, Urbana
Brandon Lockhart University of Nebraska, Lincoln
David Lovatt University of East Anglia
Greg Lucado University of the Sciences in Philadelphia
Debbie Lucas Northwestern University
Brian Lucey Trinity College, Dublin
Suren Mansinghka University of California, Irvine
Ernst Maug Mannheim University
George McCabe University of Nebraska
Eric McLaughlin California State University, Pomona
Joe Messina San Francisco State University
Tim Michael University of Houston, Clear Lake
Dag Michalsen Bl, Oslo
Franklin Michello Middle Tennessee State University
Peter Moles University of Edinburgh
Katherine Morgan Columbia University
James Nelson East Carolina University
James Owens West Texas A&M University
Darshana Palkar Minnesota State University, Mankato
Claus Parum Copenhagen Business School
Dilip Patro Rutgers University
John Percival University of Pennsylvania
Birsel Pirim University of Illinois, Urbana
Latha Ramchand University of Houston
Narendar V. Rao Northeastern University
Rathin Rathinasamy Ball State University
Raghavendra Rau Purdue University
Joshua Raugh University of Chicago
Charu Reheja Wake Forest University
Thomas Rhee California State University, Long Beach
Tom Rietz University of Iowa
Robert Ritchey Texas Tech University
Michael Roberts University of Pennsylvania
Mo Rodriguez Texas Christian University
John Rozycki Drake University
Frank Ryan San Diego State University
Marc Schauten Eramus University

Brad Scott Webster University
Nejat Seyhun University of Michigan
Jay Shanken Emory University
Chander Shekhar University of Melbourne
Hamid Shomali Golden Gate University
Richard Simonds Michigan State University
Bernell Stone Brigham Young University
John Strong College of William & Mary
Avanidhar Subrahmanyam University of California, Los
Angeles
Tim Sullivan Bentley College
Shrinivasan Sundaram Ball State University
Chu-Sheng Tai Texas Southern University
Tom Tallerico Dowling College
Stephen Todd Loyola University, Chicago
Walter Torous University of California, Los Angeles
Emery Trahan Northeastern University
Gary Tripp Southern New Hampshire University
Ilias Tsiakas University of Warwick
David Vang St. Thomas University
Steve Venti Dartmouth College
Joseph Vu DePaul University
John Wald Rutgers University
Chong Wang Naval Postgraduate School
Faye Wang University of Illinois, Chicago
Kelly Welch University of Kansas
Jill Wetmore Saginaw Valley State University
Patrick Wilkie University of Virginia
Matt Will University of Indianapolis
David Williams Texas A&M University, Commerce
Art Wilson George Washington University
Shee Wong University of Minnesota, Duluth
Bob Wood Tennessee Tech University
Fei Xie George Mason University
Minhua Yang University of Central Florida
David Zalewski Providence College
Chenying Zhang University of Pennsylvania

This list is surely incomplete. We know how much we
owe to our colleagues at the London Business School,
MIT’s Sloan School of Management, Imperial College
London, and the University of Pennsylvania’s Whar-
ton School. In many cases, the ideas that appear in this
book are as much their ideas as ours.

We would also like to thank all those at McGraw-Hill
Education who worked on the book, including Chuck Syn-
ovec, Executive Brand Manager; Allison McCabe-Carroll,
Senior Product Developer; Trina Mauer, Executive Mar-
keting Manager; Dave O’Donnell, Marketing Specialist;
Fran Simon, Project Manager; Matt Diamond, Designer;
and Angela Norris, Digital Product Analyst.

Richard A. Brealey
Stewart C. Myers

Franklin Allen

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Guided Tour

Pedagogical Features
⟩ Chapter Overview
Each chapter begins with a brief narrative and out-
line to explain the concepts that will be covered in
more depth. Useful websites related to material for
each Part are provided in the Connect library.

⟩ Finance in Practice Boxes
Relevant news articles, often from financial pub-
lications, appear in various chapters throughout
the text. Aimed at bringing real-world flavor into
the classroom, these boxes provide insight into the
business world today.

⟩ Numbered Examples
Numbered and titled examples are called out
within chapters to further illustrate concepts.
Students can learn how to solve specific problems
step-by-step and apply key principles to answer
concrete questions and scenarios.

Rev.confirming pages

● ● ●

1

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Part 1 Value

This book is about how corporations make financial decisions. We start by explaining what these decisions
are and what they are intended to accomplish.

Corporations invest in real assets, which generate income.
Some of these assets, such as plant and machinery, are tan-
gible; others, such as brand names and patents, are intangible.
Corporations finance their investments by borrowing, by retain-
ing and reinvesting cash flow, and by selling additional shares
of stock to the corporation’s shareholders. Thus, the financial
manager faces two broad financial questions: First, what invest-
ments should the corporation make? Second, how should it
pay for those investments? The investment decision involves
spending money; the financing decision involves raising it.

A large corporation may have hundreds of thousands
of shareholders. These shareholders differ in many ways,
including their wealth, risk tolerance, and investment horizon.
Yet we shall see that they usually share the same financial
objective. They want the financial manager to increase the
value of the corporation and its current stock price.

Thus, the secret of success in financial management is
to increase value. That is easy to say but not very helpful.
Instructing the financial manager to increase value is like
advising an investor in the stock market to “buy low, sell
high.” The problem is how …