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The Pearson Series in Finance. Bekaert/Hodrick. International Financial Management. Berk/DeMarzo. Corporate Finance*. Berk/DeMarzo. Applied Corporate Finance- 3rd Edition corporate finance can be summarized in figure 1, which also lays out a site map for the book. every section of this book. Corporate Finance Second Edition Berk Demarzo. Corporate Finance: Instructor Manual Applied Corporate corporate finance: instructor manual applied.

Key equations are titled and revisited in the summary and in end papers. This chapter introduces the corporation and explains alternative business organizational forms. Although they do not account for much sales revenue in the economy, they are the most common type of firm in the world, as shown in Figure 1. The Paris Stock Exchange, like other leading stock markets, has changed significantly in recent years. Scholes If the monthly interest rate you earn on your cash is 0.

Applications that Reflect Real Practice Corporate Finance features actual companies and leaders in the field. Interviews with notable practitioners—seven new for this edition—highlight leaders in the field and address the effects of the financial crisis. General Interest boxes highlight timely material from financial publications that shed light on business problems and realcompany practices.

As a novel economic federation, the ECB finds itself in a more difficult position than the Fed The xix Teaching Students to Think Finance With a consistency in presentation and an innovative set of learning aids, Corporate Finance simultaneously meets the needs of both future financial managers and non-financial managers.

Corporate Finance systematically uses: Notation Boxes: Introduced in Chapter 4, timelines are emphasized as the important first step in solving every problem that involves cash flows. See the example below: There are three things to note about the IRR function. First, the values given to the IRR function should include all of the cash flows of the project, including the one at date 0.

Finally, as we will discuss in Chapter 7, in some settings the IRR function may fail to find a solution, or may give a different answer, depending on the initial guess. Numbered and Labeled Equations: The first time a full equation is given in notation form it is numbered. Key equations are titled and revisited in the summary and in end papers. Using Excel Boxes: Provide hands-on instruction of Excel techniques and include screenshots to serve as a guide for students.

Spreadsheet Tables: Select tables are available as Excel files, enabling students to change inputs and manipulate the underlying calculations. TABLE 8. Concept Check questions at the end of each section enable students to test their understanding and target areas in which they need further review. End-of-chapter problems written personally by Jonathan Berk and Peter DeMarzo offer instructors the opportunity to assign first-rate materials to students for homework and practice with the confidence that the problems are consistent with chapter content.

Both the problems and solutions, which were also written by the authors, have been class-tested and accuracy-checked to ensure quality. Many questions involve the use of Internet resources and Excel techniques.

Finance645G.2019.Term3.NatashaKingery.Case.pdf - DUKE...

From the prospectus, calculate the following information: The underwriting spread in percentage terms. How does this spread compare to a typical IPO? The fraction of the offering that comprised primary shares and the fraction that comprised secondary shares.

Pdf demarzo corporate finance

The size, in number of shares, of the greenshoe provision. What percent of the deal did the greenshoe provision represent? What was the first day return? How does this return compare to the typical IPO? That is, calculate the annualized return an investor would have received if he had invested in Facebook at the closing price on the IPO day and sold the stock three months later. What was the return for a one-year holding period? MyFinanceLab Because practice with homework problems is crucial to learning finance, Corporate Finance is available with MyFinanceLab, a fully integrated homework and tutorial system.

Online Assessment Using End-of-Chapter Problems The seamless integration among the textbook, assessment materials, and online resources sets a new standard in corporate finance education. End-of-chapter problems—every single one —appear online. The values in the problems are algorithmically generated, giving students many opportunities for practice and mastery. Problems can be assigned by professors and completed online by students. Helpful tutorial tools, along with the same pedagogical aids from the text, support students as they study.

Links to the eText direct students right to the material they most need to review. Additional Resources in Video clips profile high-profile firms such as Boeing, Cisco, Delta, and Intel through interviews and analysis. The videos focus on core topical areas, including capital budgeting, mergers and acquisitions, and risk and return. Interactive animations, which enable students to manipulate inputs, cover topics such as bonds, stock valuation, NPV, IRR, financial statement modeling, and more.

Finance in the News provides weekly postings of a relevant and current article from a newspaper or journal article with discussion questions that are assignable in MyFinanceLab. To learn more about MyFinanceLab, contact your local Pearson representative www.

With the Study Plan, students learn to focus their energies on the topics they need to be successful in class, on exams, and, ultimately, in their careers. Powerful Instructor Tools MyFinanceLab provides flexible tools that enable instructors to easily customize the online course materials to suit their needs. Easy-to-Use Homework Manager. Instructors can easily create and assign tests, quizzes, or graded homework assignments. In addition to pre-built MyFinanceLab questions, the Test Bank is also available so that instructors have ample material with which to create assignments.

Flexible Gradebook. Downloadable Classroom Resources. Prior to earning his Ph. Murray Prize. Born in Johannesburg, South Africa, Professor Berk is married, with two daughters, and is an avid skier and biker. He currently teaches MBA and Ph. Cheit Outstanding Teaching Award at U. Berkeley in His recent work has examined issues of the optimal design of contracts and securities, the regulation of insider trading and broker-dealers, and the influence of information asymmetries on corporate investment.

He and his family enjoy hiking, biking, and skiing. The core concepts in finance are simple and intuitive.

What makes the subject challenging is that it is often difficult for a novice to distinguish between these core ideas and other intuitively appealing approaches that, if used in financial decision making, will lead to incorrect decisions. De-emphasizing the core concepts that underlie finance strips students of the essential intellectual tools they need to differentiate between good and bad decision making.

We present corporate finance as an application of a set of simple, powerful ideas. This simple concept is a powerful and important tool in financial decision making.

By relying on it, and the other core principles in this book, financial decision makers can avoid the bad decisions brought to light by the recent financial crisis. We use the Law of One Price as a compass; it keeps financial decision makers on the right track and is the backbone of the entire book. New to This Edition We have updated all text discussions and figures, tables and facts to accurately reflect developments in the field in the last four years. Specific highlights include the following: The — financial crisis and European sovereign debt crisis provide a valuable pedagogical illustration of what can go wrong when practitioners ignore the core concepts that underlie financial decision making.

We integrate this important lesson into the book in a series of contextual Global Financial Crisis boxes. These boxes—23 in total across the book—bring the relevance of the crises home to students by illustrating and analyzing key details about the financial crisis and sovereign debt dynamics.

New centralized coverage of financial ratios in Chapter 2 in a specific section provides students with the tools to analyze financial statements. Seven new practitioner interviews incorporate timely perspectives from leaders in the field related to the recent financial crisis and ongoing European sovereign debt crisis.

New Using Excel boxes provide hands-on instruction of how to use Excel to solve financial problems and include screenshots to serve as a guide for students. We added 45 new problems and refined many others, once again personally writing and solving each one. In addition, every single problem is available in MyFinanceLab, the groundbreaking homework and tutorial system that accompanies the book. The Law of One Price as the Unifying Principle of Valuation This book presents corporate finance as an application of a small set of simple core ideas.

Modern finance theory and practice is grounded in the idea of the absence of arbitrage—or the Law of One Price—as the unifying concept in valuation. In the opening of each part and as pertinent throughout the remaining chapters, we relate major concepts to the Law of One Price, creating a framework to ground the student reader and connect theory to practice.

Table of Contents Overview Corporate Finance offers coverage of the major topical areas for introductory-level MBA students as well as the depth required in a reference textbook for upper-division courses. Most professors customize their classes by selecting a subset of chapters reflecting the subject matter they consider most important. We designed this book from the outset with this need for flexibility in mind. Parts 2 through 6 are the core chapters in the book. We envision that most MBA programs will cover this material—yet even within these core chapters instructors can pick and choose.

Single quarter course: Cover Chapters 3—15; if time allows, or students are previously familiar with the time value of money, add on Chapters 16— Semester-long course: Incorporate options and Part 10, Special Topics, chapters as desired. Single mini-semester: Assign Chapters 3—10, 14, and 15 if time allows.

Reinhart, John F.

For more details, see pages xxi—xxii. Provides detailed, accuracy-verified, class-tested solutions to every chapter problem. Corresponding to each chapter, provides: Provides a wide selection of multiple-choice, short answer, and essay questions qualified by difficulty level and skill type and correlated to chapter topics.

Numerical-based problems include step-by-step solutions. Offers outlines of each chapter with graphs, tables, key terms, and concepts from each chapter. Worked examples provide detailed, step-by-step solutions in the same format as the boxes from the text and correlated to parallel specific textbook examples. Provides the learning tools students need to cement their understanding of key concepts, including chapter synopses, review of select concepts and terms, and 5—10 questions per chapter as a self-test.

Available for download at MyFinanceLab. Focus on core topical areas such as capital budgeting and risk and return. Available in MyFinanceLab. Acknowledgments Looking back, it is hard to believe that this book is in its third edition. We are heartened by its success and impact on the profession through shaping future practitioners. As any textbook writer will tell you, achieving this level of success requires a substantial amount of help. First and foremost we thank Donna Battista, whose leadership, talent, and market savvy are imprinted on all aspects of the project and are central to its success; Denise Clinton, a friend and a leader in fact not just in name, whose experience and knowledge are indispensable; Rebecca Ferris-Caruso, for her unparalleled expertise in managing the complex writing, reviewing, and editing processes and patience in keeping us on track—it is impossible to imagine writing the book without her; Jami Minard, for spearheading marketing efforts; Katie Rowland, for her energy and fresh perspective as our new editor; and Miguel Leonarte, for his central role on MyFinanceLab.

We were blessed to be approached by the best publisher in the business and we are both truly thankful for the indispensable help provided by these and other professionals, including Emily Biberger, Dottie Dennis, Nancy Freihofer, Gillian Hall, Melissa Honig, Carol Melville, and Elissa Senra-Sargent. Updating a textbook like ours requires a lot of painstaking work, and there are many who have provided insights and input along the way. We would especially like to call out Jared Stanfield for his important contributions and suggestions throughout.

We also thank Rebecca Greenberg and Robert James for their tireless efforts to make sure this edition remained as error-free as the past editions have been.

Pdf demarzo corporate finance

Of course, this third edition text is built upon the shoulders of the first two, and we have many to thank for helping us make those early versions a reality. Many of the later, non-core chapters required specific detailed knowledge.

Joseph Vu and Vance P. Lesseig contributed their talents to the Concept Check questions and Data Cases, respectively.

Creating a truly error-free text is a challenge we could not have lived up to without our team of expert error checkers; we owe particular thanks to Siddharth Bellur, Robert James, Anand Goel, Ian Drummond Gow, Janet Payne, and Jared Stanfield. Thomas Gilbert and Miguel Palacios tirelessly worked examples and problems in the first edition, while providing numerous insights along the way.

A corporate finance textbook is the product of the talents and hard work of many talented colleagues. We are especially gratified with the work of those who updated the impressive array of print supplements to accompany the book: Preface xxix As a colleague of both of us, Mark Rubinstein inspired us with his passion to get the history of finance right by correctly attributing the important ideas to the people who first enunciated them.

We have used his book, A History of the Theory of Investments: My Annotated Bibliography, extensively in this text and we, as well as the profession as a whole, owe him a debt of gratitude for taking the time to write it all down.

We could not have written this text if we were not once ourselves students of finance. As any student knows, the key to success is having a great teacher. In our case we are lucky to have been taught and advised by the people who helped create modern finance: It was from them that we learned the importance of the core principles of finance, including the Law of One Price, on which this book is based.

The learning process does not end at graduation and like most people we have had especially influential colleagues and mentors from which we learned a great deal during our careers and we would like to recognize them explicitly here: We continue to learn from all of our colleagues and we are grateful to all of them.

Finally, we would like to thank those with whom we have taught finance classes over the years: Their ideas and teaching strategies have without a doubt influenced our own sense of pedagogy and found their way into this text.

Finally, and most importantly, we owe our biggest debt of gratitude to our spouses, Rebecca Schwartz and Kaui Chun DeMarzo. Little did we or they know how much this project would impact our lives, and without their continued love and support—and especially their patience and understanding—this text could not have been completed.

We owe a special thanks to Kaui DeMarzo, for her inspiration and support at the start of this project, and for her willingness to be our in-house editor, contributor, advisor, and overall sounding-board throughout each stage of its development. Jonathan Berk Peter DeMarzo Contributors We are truly thankful to have had so many manuscript reviewers, class testers, and focus group participants.

We are very grateful for all comments—both informal and in written evaluations— from Second Edition users. We carefully weighed each reviewer suggestion as we sought to streamline the narrative to improve clarity and add relevant new material.

The book has benefited enormously for this input. Reviewers Ashok B. Reese, Jr. Ryan, Jr. The focus of this book is how to make optimal corporate financial decisions. In this part of the book, we lay the foundation for our study of corporate finance.

We begin, in Chapter 1, by introducing the corporation and related business forms. We then examine the role of financial managers and outside investors in decision making for the firm.

To make optimal decisions, a decision maker needs information. We then introduce the most important idea in this book, the concept of the absence of arbitrage or Law of One Price in Chapter 3. The Law of One Price states that we can use market prices to determine the value of an investment opportunity to the firm. We will return to this theme throughout our study of Corporate Finance. On that day the U. Supreme Court established the legal precedent that the property of a corporation, like that of a person, is private and entitled to protection under the U.

However, before the Supreme Court decision, the owners of a corporation were exposed to the possibility that the state could take their business. This concern was real enough to stop most businesses from incorporating and, indeed, in that concern was realized: The state seized Dartmouth College. Dartmouth College was incorporated in as a private educational institution governed by a self-perpetuating board of trustees.

Unhappy with the political leanings of the board, the state legislature effectively took control of Dartmouth by passing legislation in that established a governor-appointed board of overseers to run the school. The legislation had the effect of turning a private university under private control into a state university under state control. If such an act were constitutional, it implied that any state or the federal government could, at will, nationalize any corporation.

Dartmouth sued for its independence and the case made it to the Supreme Court under Chief Justice John Marshall in Owners of businesses could incorporate and still enjoy the protection of private property, as well as protection from seizure, both guaranteed by the U.

The modern business corporation was born. In the financial crisis once again transformed the financial landscape, bringing down giants like Bear Stearns, Lehman Brothers, and AIG and reshaping investment banks like Goldman Sachs into government-guaranteed commercial banks. These changes have as profound an effect on the future of corporate finance as the Dartmouth decision did almost years ago.

Government bailouts have provoked challenging questions regarding the role of the federal government in the control and management of private corporations.

In the wake of the crisis, significant reforms of the regulation and oversight of financial markets were passed into law. Understanding the principles of corporate finance has never been more important to the practice of business than it is now, during this time of great change. The focus of this book is on how people in corporations make financial decisions.

Jonathan B Berk; Peter M DeMarzo Corporate Finance.pdf

This chapter introduces the corporation and explains alternative business organizational forms. A key factor in the success of corporations is the ability to easily trade ownership shares, and so we will also explain the role of stock markets in facilitating trading among investors in a corporation and the implications that has for the ownership and control of corporations. We explain each organizational form in turn, but our primary focus is on the most important form—the corporation.

In addition to describing what a corporation is, we also provide an overview of why corporations are so successful. Sole Proprietorships A sole proprietorship is a business owned and run by one person. Sole proprietorships are usually very small with few, if any, employees. Although they do not account for much sales revenue in the economy, they are the most common type of firm in the world, as shown in Figure 1.

Sole proprietorships share the following key characteristics: Sole proprietorships are straightforward to set up. Consequently, many new businesses use this organizational form. The principal limitation of a sole proprietorship is that there is no separation between the firm and the owner—the firm can have only one owner.

If there are other investors, they cannot hold an ownership stake in the firm. That is, if the firm defaults on any debt payment, the lender can and will require the owner to 2 This information, as well as other small business statistics, can be found at www.

See their on-site disclosures page for a description of their methodology. Firms There are four different types of firms in the United States. As a and b show, although the majority of U. An owner who cannot afford to repay the loan must declare personal bankruptcy. The life of a sole proprietorship is limited to the life of the owner.

It is also difficult to transfer ownership of a sole proprietorship. For most businesses, the disadvantages of a sole proprietorship outweigh the advantages. Partnerships A partnership is identical to a sole proprietorship except it has more than one owner. The following are key features of a partnership: The partnership ends on the death or withdrawal of any single partner, although partners can avoid liquidation if the partnership agreement provides for alternatives such as a buyout of a deceased or withdrawn partner.

Some old and established businesses remain partnerships or sole proprietorships. For example, law firms, groups of doctors, and accounting firms are often organized as partnerships. A limited partnership is a partnership with two kinds of owners, general partners and limited partners. Limited partners, however, have limited liability—that is, their liability is limited to their investment.

Furthermore, the death or withdrawal of a limited partner does not dissolve the partnership, 1. However, a limited partner has no management authority and cannot legally be involved in the managerial decision making for the business.

Private equity funds and venture capital funds are two examples of industries dominated by limited partnerships. In these firms, a few general partners contribute some of their own capital and raise additional capital from outside investors who are limited partners.

The general partners control how all the capital is invested. Most often they will actively participate in running the businesses they choose to invest in. The outside investors play no active role in the partnership other than monitoring how their investments are performing.

That is, all the owners have limited liability, but unlike limited partners, they can also run the business. The first state to pass a statute allowing the creation of an LLC was Wyoming in ; the last was Hawaii in Internationally, companies with limited liability are much older and established.

Corporations The distinguishing feature of a corporation is that it is a legally defined, artificial being a judicial person or legal entity , separate from its owners. As such, it has many of the legal powers that people have. It can enter into contracts, acquire assets, incur obligations, and, as we have already established, it enjoys protection under the U. Constitution against the seizure of its property. Because a corporation is a legal entity separate and distinct from its owners, it is solely responsible for its own obligations.

Consequently, the owners of a corporation or its employees, customers, etc. Similarly, the corporation is not liable for any personal obligations of its owners. Formation of a Corporation. Corporations must be legally formed, which means that the state in which it is incorporated must formally give its consent to the incorporation by chartering it.

Setting up a corporation is therefore considerably more costly than setting up a sole proprietorship. Delaware has a particularly attractive legal environment for corporations, so many corporations choose to incorporate there. For jurisdictional purposes, a corporation is a citizen of the state in which it is incorporated. Most firms hire lawyers to create a corporate charter that includes formal articles of incorporation and a set of bylaws.

The corporate charter specifies the initial rules that govern how the corporation is run. Ownership of a Corporation. There is no limit on the number of owners a corporation can have. Because most corporations have many owners, each owner owns only a small fraction of the corporation. The entire ownership stake of a corporation is divided into shares known as stock. The collection of all the outstanding shares of a corporation is known as the equity of the corporation.

An owner of a share of stock in the corporation is known as a shareholder, stockholder, or equity holder and is entitled to dividend payments, that is, payments made at the discretion of the corporation to its equity holders. A unique feature of a corporation is that there is no limitation on who can own its stock. That is, an owner of a corporation need not have any special expertise or qualification.

This feature allows free trade in the shares of the corporation and provides one of the most important advantages of organizing a firm as a corporation rather than as sole proprietorship, partnership, or LLC. Corporations can raise substantial amounts of capital because they can sell ownership shares to anonymous outside investors. The availability of outside funding has enabled corporations to dominate the economy, as shown by Panel b of Figure 1. Tax Implications for Corporate Entities An important difference between the types of organizational forms is the way they are taxed.

In effect, shareholders of a corporation pay taxes twice. First, the corporation pays tax on its profits, and then when the remaining profits are distributed to the shareholders, the shareholders pay their own personal income tax on this income.

Pdf demarzo corporate finance

This system is sometimes referred to as double taxation. After it has paid taxes, it will distribute the rest of its earnings to you as a dividend. The dividend is income to you, so you will then pay taxes on these earnings. How much of the earnings remains after all taxes are paid?

Solution First, the corporation pays taxes. However, you must pay 0. Thus, your total effective tax rate is 2.

S Corporations. The corporate organizational structure is the only organizational structure subject to double taxation. However, the U. A few countries, including Australia, Finland, Mexico, New Zealand, and Norway, offer complete relief by effectively not taxing dividend income. The United States offers partial relief by having a lower tax rate on dividend income than on other sources of income.

The shareholders must include these profits as income on their individual tax returns even if no money is distributed to them. However, after the shareholders have paid income taxes on these profits, no further tax is due. Solution In this case, the corporation pays no taxes. Whether or not the corporation chooses to distribute or retain this cash, you must pay 0. The government places strict limitations on the qualifications for subchapter S tax treatment.

MyFinanceLab Because practice with homework problems is crucial to learning finance, Corporate Finance is available with MyFinanceLab, a fully integrated homework and tutorial system. Online Assessment Using End-of-Chapter Problems The seamless integration among the textbook, assessment materials, and online resources sets a new standard in corporate finance education.

End-of-chapter problems—every single one —appear online. The values in the problems are algorithmically generated, giving students many opportunities for practice and mastery. Problems can be assigned by professors and completed online by students. Helpful tutorial tools, along with the same pedagogical aids from the text, support students as they study. Links to the eText direct students right to the material they most need to review.

Additional Resources in Video clips profile high-profile firms such as Boeing, Cisco, Delta, and Intel through interviews and analysis. The videos focus on core topical areas, including capital budgeting, mergers and acquisitions, and risk and return. Interactive animations, which enable students to manipulate inputs, cover topics such as bonds, stock valuation, NPV, IRR, financial statement modeling, and more. Finance in the News provides weekly postings of a relevant and current article from a newspaper or journal article with discussion questions that are assignable in MyFinanceLab.

To learn more about MyFinanceLab, contact your local Pearson representative www. With the Study Plan, students learn to focus their energies on the topics they need to be successful in class, on exams, and, ultimately, in their careers. Powerful Instructor Tools MyFinanceLab provides flexible tools that enable instructors to easily customize the online course materials to suit their needs.

Easy-to-Use Homework Manager. Instructors can easily create and assign tests, quizzes, or graded homework assignments. In addition to pre-built MyFinanceLab questions, the Test Bank is also available so that instructors have ample material with which to create assignments.

Flexible Gradebook. Downloadable Classroom Resources. Prior to earning his Ph.

Finance demarzo pdf corporate

Murray Prize. Born in Johannesburg, South Africa, Professor Berk is married, with two daughters, and is an avid skier and biker. He currently teaches MBA and Ph. Cheit Outstanding Teaching Award at U. Berkeley in His recent work has examined issues of the optimal design of contracts and securities, the regulation of insider trading and broker-dealers, and the influence of information asymmetries on corporate investment. He and his family enjoy hiking, biking, and skiing. The core concepts in finance are simple and intuitive.

What makes the subject challenging is that it is often difficult for a novice to distinguish between these core ideas and other intuitively appealing approaches that, if used in financial decision making, will lead to incorrect decisions. De-emphasizing the core concepts that underlie finance strips students of the essential intellectual tools they need to differentiate between good and bad decision making.

We present corporate finance as an application of a set of simple, powerful ideas. This simple concept is a powerful and important tool in financial decision making. By relying on it, and the other core principles in this book, financial decision makers can avoid the bad decisions brought to light by the recent financial crisis.

We use the Law of One Price as a compass; it keeps financial decision makers on the right track and is the backbone of the entire book. New to This Edition We have updated all text discussions and figures, tables and facts to accurately reflect developments in the field in the last four years.

Specific highlights include the following: The — financial crisis and European sovereign debt crisis provide a valuable pedagogical illustration of what can go wrong when practitioners ignore the core concepts that underlie financial decision making. We integrate this important lesson into the book in a series of contextual Global Financial Crisis boxes. These boxes—23 in total across the book—bring the relevance of the crises home to students by illustrating and analyzing key details about the financial crisis and sovereign debt dynamics.

New centralized coverage of financial ratios in Chapter 2 in a specific section provides students with the tools to analyze financial statements.

Seven new practitioner interviews incorporate timely perspectives from leaders in the field related to the recent financial crisis and ongoing European sovereign debt crisis. New Using Excel boxes provide hands-on instruction of how to use Excel to solve financial problems and include screenshots to serve as a guide for students.

We added 45 new problems and refined many others, once again personally writing and solving each one. In addition, every single problem is available in MyFinanceLab, the groundbreaking homework and tutorial system that accompanies the book. The Law of One Price as the Unifying Principle of Valuation This book presents corporate finance as an application of a small set of simple core ideas.

Modern finance theory and practice is grounded in the idea of the absence of arbitrage—or the Law of One Price—as the unifying concept in valuation. In the opening of each part and as pertinent throughout the remaining chapters, we relate major concepts to the Law of One Price, creating a framework to ground the student reader and connect theory to practice.

Table of Contents Overview Corporate Finance offers coverage of the major topical areas for introductory-level MBA students as well as the depth required in a reference textbook for upper-division courses. Most professors customize their classes by selecting a subset of chapters reflecting the subject matter they consider most important.

We designed this book from the outset with this need for flexibility in mind. Parts 2 through 6 are the core chapters in the book. We envision that most MBA programs will cover this material—yet even within these core chapters instructors can pick and choose. Single quarter course: Cover Chapters 3—15; if time allows, or students are previously familiar with the time value of money, add on Chapters 16— Semester-long course: Incorporate options and Part 10, Special Topics, chapters as desired.

Single mini-semester: Assign Chapters 3—10, 14, and 15 if time allows. Reinhart, John F. For more details, see pages xxi—xxii. Provides detailed, accuracy-verified, class-tested solutions to every chapter problem. Corresponding to each chapter, provides: Provides a wide selection of multiple-choice, short answer, and essay questions qualified by difficulty level and skill type and correlated to chapter topics.

Numerical-based problems include step-by-step solutions. Offers outlines of each chapter with graphs, tables, key terms, and concepts from each chapter. Worked examples provide detailed, step-by-step solutions in the same format as the boxes from the text and correlated to parallel specific textbook examples. Provides the learning tools students need to cement their understanding of key concepts, including chapter synopses, review of select concepts and terms, and 5—10 questions per chapter as a self-test.

Available for download at MyFinanceLab. Focus on core topical areas such as capital budgeting and risk and return. Available in MyFinanceLab. Acknowledgments Looking back, it is hard to believe that this book is in its third edition.

We are heartened by its success and impact on the profession through shaping future practitioners. As any textbook writer will tell you, achieving this level of success requires a substantial amount of help.

First and foremost we thank Donna Battista, whose leadership, talent, and market savvy are imprinted on all aspects of the project and are central to its success; Denise Clinton, a friend and a leader in fact not just in name, whose experience and knowledge are indispensable; Rebecca Ferris-Caruso, for her unparalleled expertise in managing the complex writing, reviewing, and editing processes and patience in keeping us on track—it is impossible to imagine writing the book without her; Jami Minard, for spearheading marketing efforts; Katie Rowland, for her energy and fresh perspective as our new editor; and Miguel Leonarte, for his central role on MyFinanceLab.

We were blessed to be approached by the best publisher in the business and we are both truly thankful for the indispensable help provided by these and other professionals, including Emily Biberger, Dottie Dennis, Nancy Freihofer, Gillian Hall, Melissa Honig, Carol Melville, and Elissa Senra-Sargent.

Updating a textbook like ours requires a lot of painstaking work, and there are many who have provided insights and input along the way. We would especially like to call out Jared Stanfield for his important contributions and suggestions throughout. We also thank Rebecca Greenberg and Robert James for their tireless efforts to make sure this edition remained as error-free as the past editions have been.

Of course, this third edition text is built upon the shoulders of the first two, and we have many to thank for helping us make those early versions a reality.

Many of the later, non-core chapters required specific detailed knowledge. Joseph Vu and Vance P. Lesseig contributed their talents to the Concept Check questions and Data Cases, respectively. Creating a truly error-free text is a challenge we could not have lived up to without our team of expert error checkers; we owe particular thanks to Siddharth Bellur, Robert James, Anand Goel, Ian Drummond Gow, Janet Payne, and Jared Stanfield.

Thomas Gilbert and Miguel Palacios tirelessly worked examples and problems in the first edition, while providing numerous insights along the way. A corporate finance textbook is the product of the talents and hard work of many talented colleagues.

We are especially gratified with the work of those who updated the impressive array of print supplements to accompany the book: Preface xxix As a colleague of both of us, Mark Rubinstein inspired us with his passion to get the history of finance right by correctly attributing the important ideas to the people who first enunciated them. We have used his book, A History of the Theory of Investments: My Annotated Bibliography, extensively in this text and we, as well as the profession as a whole, owe him a debt of gratitude for taking the time to write it all down.

We could not have written this text if we were not once ourselves students of finance. As any student knows, the key to success is having a great teacher. In our case we are lucky to have been taught and advised by the people who helped create modern finance: It was from them that we learned the importance of the core principles of finance, including the Law of One Price, on which this book is based. The learning process does not end at graduation and like most people we have had especially influential colleagues and mentors from which we learned a great deal during our careers and we would like to recognize them explicitly here: We continue to learn from all of our colleagues and we are grateful to all of them.

Finally, we would like to thank those with whom we have taught finance classes over the years: Their ideas and teaching strategies have without a doubt influenced our own sense of pedagogy and found their way into this text.

Finally, and most importantly, we owe our biggest debt of gratitude to our spouses, Rebecca Schwartz and Kaui Chun DeMarzo. Little did we or they know how much this project would impact our lives, and without their continued love and support—and especially their patience and understanding—this text could not have been completed.

We owe a special thanks to Kaui DeMarzo, for her inspiration and support at the start of this project, and for her willingness to be our in-house editor, contributor, advisor, and overall sounding-board throughout each stage of its development. Jonathan Berk Peter DeMarzo Contributors We are truly thankful to have had so many manuscript reviewers, class testers, and focus group participants. We are very grateful for all comments—both informal and in written evaluations— from Second Edition users.

We carefully weighed each reviewer suggestion as we sought to streamline the narrative to improve clarity and add relevant new material. The book has benefited enormously for this input. Reviewers Ashok B. Reese, Jr. Ryan, Jr. The focus of this book is how to make optimal corporate financial decisions.

In this part of the book, we lay the foundation for our study of corporate finance. We begin, in Chapter 1, by introducing the corporation and related business forms.

We then examine the role of financial managers and outside investors in decision making for the firm.

To make optimal decisions, a decision maker needs information. We then introduce the most important idea in this book, the concept of the absence of arbitrage or Law of One Price in Chapter 3. The Law of One Price states that we can use market prices to determine the value of an investment opportunity to the firm. We will return to this theme throughout our study of Corporate Finance. On that day the U.

Supreme Court established the legal precedent that the property of a corporation, like that of a person, is private and entitled to protection under the U.

However, before the Supreme Court decision, the owners of a corporation were exposed to the possibility that the state could take their business.

This concern was real enough to stop most businesses from incorporating and, indeed, in that concern was realized: The state seized Dartmouth College. Dartmouth College was incorporated in as a private educational institution governed by a self-perpetuating board of trustees.

Unhappy with the political leanings of the board, the state legislature effectively took control of Dartmouth by passing legislation in that established a governor-appointed board of overseers to run the school. The legislation had the effect of turning a private university under private control into a state university under state control.

If such an act were constitutional, it implied that any state or the federal government could, at will, nationalize any corporation.

Dartmouth sued for its independence and the case made it to the Supreme Court under Chief Justice John Marshall in Owners of businesses could incorporate and still enjoy the protection of private property, as well as protection from seizure, both guaranteed by the U.

The modern business corporation was born. In the financial crisis once again transformed the financial landscape, bringing down giants like Bear Stearns, Lehman Brothers, and AIG and reshaping investment banks like Goldman Sachs into government-guaranteed commercial banks. These changes have as profound an effect on the future of corporate finance as the Dartmouth decision did almost years ago. Government bailouts have provoked challenging questions regarding the role of the federal government in the control and management of private corporations.

In the wake of the crisis, significant reforms of the regulation and oversight of financial markets were passed into law. Understanding the principles of corporate finance has never been more important to the practice of business than it is now, during this time of great change. The focus of this book is on how people in corporations make financial decisions. This chapter introduces the corporation and explains alternative business organizational forms.

A key factor in the success of corporations is the ability to easily trade ownership shares, and so we will also explain the role of stock markets in facilitating trading among investors in a corporation and the implications that has for the ownership and control of corporations. We explain each organizational form in turn, but our primary focus is on the most important form—the corporation. In addition to describing what a corporation is, we also provide an overview of why corporations are so successful.

Sole Proprietorships A sole proprietorship is a business owned and run by one person. Sole proprietorships are usually very small with few, if any, employees. Although they do not account for much sales revenue in the economy, they are the most common type of firm in the world, as shown in Figure 1.

Sole proprietorships share the following key characteristics: Sole proprietorships are straightforward to set up. Consequently, many new businesses use this organizational form. The principal limitation of a sole proprietorship is that there is no separation between the firm and the owner—the firm can have only one owner.

If there are other investors, they cannot hold an ownership stake in the firm. That is, if the firm defaults on any debt payment, the lender can and will require the owner to 2 This information, as well as other small business statistics, can be found at www.

See their on-site disclosures page for a description of their methodology. Firms There are four different types of firms in the United States.

As a and b show, although the majority of U. An owner who cannot afford to repay the loan must declare personal bankruptcy. The life of a sole proprietorship is limited to the life of the owner. It is also difficult to transfer ownership of a sole proprietorship. For most businesses, the disadvantages of a sole proprietorship outweigh the advantages.

Partnerships A partnership is identical to a sole proprietorship except it has more than one owner. The following are key features of a partnership: The partnership ends on the death or withdrawal of any single partner, although partners can avoid liquidation if the partnership agreement provides for alternatives such as a buyout of a deceased or withdrawn partner.

Some old and established businesses remain partnerships or sole proprietorships. For example, law firms, groups of doctors, and accounting firms are often organized as partnerships. A limited partnership is a partnership with two kinds of owners, general partners and limited partners. Limited partners, however, have limited liability—that is, their liability is limited to their investment.

Furthermore, the death or withdrawal of a limited partner does not dissolve the partnership, 1. However, a limited partner has no management authority and cannot legally be involved in the managerial decision making for the business. Private equity funds and venture capital funds are two examples of industries dominated by limited partnerships.

In these firms, a few general partners contribute some of their own capital and raise additional capital from outside investors who are limited partners. The general partners control how all the capital is invested.

Most often they will actively participate in running the businesses they choose to invest in. The outside investors play no active role in the partnership other than monitoring how their investments are performing. That is, all the owners have limited liability, but unlike limited partners, they can also run the business. The first state to pass a statute allowing the creation of an LLC was Wyoming in ; the last was Hawaii in Internationally, companies with limited liability are much older and established.

Corporations The distinguishing feature of a corporation is that it is a legally defined, artificial being a judicial person or legal entity , separate from its owners. As such, it has many of the legal powers that people have. It can enter into contracts, acquire assets, incur obligations, and, as we have already established, it enjoys protection under the U.

Constitution against the seizure of its property. Because a corporation is a legal entity separate and distinct from its owners, it is solely responsible for its own obligations. Consequently, the owners of a corporation or its employees, customers, etc.

Similarly, the corporation is not liable for any personal obligations of its owners. Formation of a Corporation. Corporations must be legally formed, which means that the state in which it is incorporated must formally give its consent to the incorporation by chartering it. Setting up a corporation is therefore considerably more costly than setting up a sole proprietorship.

Delaware has a particularly attractive legal environment for corporations, so many corporations choose to incorporate there. For jurisdictional purposes, a corporation is a citizen of the state in which it is incorporated. Most firms hire lawyers to create a corporate charter that includes formal articles of incorporation and a set of bylaws.

The corporate charter specifies the initial rules that govern how the corporation is run. Ownership of a Corporation. There is no limit on the number of owners a corporation can have. Because most corporations have many owners, each owner owns only a small fraction of the corporation. The entire ownership stake of a corporation is divided into shares known as stock. The collection of all the outstanding shares of a corporation is known as the equity of the corporation.

An owner of a share of stock in the corporation is known as a shareholder, stockholder, or equity holder and is entitled to dividend payments, that is, payments made at the discretion of the corporation to its equity holders. A unique feature of a corporation is that there is no limitation on who can own its stock. That is, an owner of a corporation need not have any special expertise or qualification. This feature allows free trade in the shares of the corporation and provides one of the most important advantages of organizing a firm as a corporation rather than as sole proprietorship, partnership, or LLC.

Corporations can raise substantial amounts of capital because they can sell ownership shares to anonymous outside investors. The availability of outside funding has enabled corporations to dominate the economy, as shown by Panel b of Figure 1.

Tax Implications for Corporate Entities An important difference between the types of organizational forms is the way they are taxed. In effect, shareholders of a corporation pay taxes twice. First, the corporation pays tax on its profits, and then when the remaining profits are distributed to the shareholders, the shareholders pay their own personal income tax on this income. This system is sometimes referred to as double taxation. After it has paid taxes, it will distribute the rest of its earnings to you as a dividend.

The dividend is income to you, so you will then pay taxes on these earnings. How much of the earnings remains after all taxes are paid? Solution First, the corporation pays taxes. However, you must pay 0. Thus, your total effective tax rate is 2.

S Corporations. The corporate organizational structure is the only organizational structure subject to double taxation. However, the U. A few countries, including Australia, Finland, Mexico, New Zealand, and Norway, offer complete relief by effectively not taxing dividend income.

The United States offers partial relief by having a lower tax rate on dividend income than on other sources of income. The shareholders must include these profits as income on their individual tax returns even if no money is distributed to them. However, after the shareholders have paid income taxes on these profits, no further tax is due. Solution In this case, the corporation pays no taxes. Whether or not the corporation chooses to distribute or retain this cash, you must pay 0.

The government places strict limitations on the qualifications for subchapter S tax treatment. In particular, the shareholders of such corporations must be individuals who are U. Because most corporations have no restrictions on who owns their shares or the number of shareholders, they cannot qualify for subchapter S treatment. What is a limited liability company LLC? How does it differ from a limited partnership?

What are the advantages and disadvantages of organizing a business as a corporation? That is, in a corporation, direct control and ownership are often separate.

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Rather than the owners, the board of directors and chief executive officer possess direct control of the corporation. In this section, we explain how the responsibilities for the corporation are divided between these two entities and how together they shape and execute the goals of the firm. The Corporate Management Team The shareholders of a corporation exercise their control by electing a board of directors, a group of people who have the ultimate decision-making authority in the corporation.

What are the advantages of partnerships and corporations? We debated this question at length when we were deciding whether to go public or stay a private partnership in the mids. There were good arguments on both sides. Those in favor of going public argued we needed greater financial and strategic flexibility to achieve our aggressive growth and market leadership goals. As a public corporation, we would have a more stable equity base to support growth and disperse risk; increased access to large public debt markets; publicly traded securities with which to undertake acquisitions and reward and motivate our employees; and a simpler and more transparent structure with which to increase scale and global reach.

Those against going public argued our private partnership structure worked well and would enable us to achieve our financial and strategic goals. As a private partnership, we could generate enough capital internally and in the private placement markets to fund growth; take a longer-term view of returns on our investments with less focus on earnings volatility, which is not valued in public companies; and retain voting control and alignment of the partners and the firm.

A big perceived advantage of our private partnership was its sense of distinctiveness and mystique, which reinforced our culture of teamwork and excellence and helped differentiate us from our competitors. Many questioned whether the special qualities of our culture would survive if the firm went public.

What was the driving force behind the conversion? We ultimately decided to go public for three main reasons: Did the conversion achieve its goals? As a public company, we have a simpler, bigger and more permanent capital base, including enhanced long-term borrowing capacity in the public debt markets.

We have drawn on substantial capital resources to serve clients, take advantage of new business opportunities, and better control our own destiny through changing economic and business conditions.

We have been able to use stock to finance key acquisitions and support large strategic and financial investments. Given how the stakes in our industry changed, how capital demands grew, going public when we did fortunately positioned us to compete effectively through the cycle.

Our distinctive culture of teamwork and excellence has thrived in public form, and our equity compensation programs turned out better than we could have hoped. Making everyone at Goldman Sachs an owner, rather than just partners, energized all our employees. The growing size and scope of our business—not the change to public form—has presented the greatest challenges to the positive aspects of our culture. The market environment had become extraordinarily unstable following the collapse of Bear Stearns in March Following the bankruptcy of Lehman Brothers and the sale of Merrill Lynch in the middle of September, and notwithstanding the reporting of quite strong earnings by both Goldman Sachs and Morgan Stanley, it became clear to us that the market viewed oversight by the Federal Reserve and the ability to source insured bank deposits as offering a greater degree of safety and soundness.

By changing our status, we gained all the benefits available to our commercial banking peers, including access to permanent liquidity and funding, without affecting our ability to operate or own any of our current businesses or investments.

When one or two shareholders own a very large proportion of the outstanding stock, these shareholders may either be on the board of directors themselves, or they may have the right to appoint a number of directors. The board of directors makes rules on how the corporation should be run including how the top managers in the corporation are compensated , sets policy, and monitors the performance of the company.