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After reading attached image-1 & image-2 and after reading chapters 1,2,3 & 19(from attached textbook) answer the questions mentioned in image attachments(1&2). 
Answer should be in own words and in APA format.

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corporate finance

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Stephen A. Ross
Franco Modigliani Professor of Finance and
Sloan School of Management
Massachusetts Institute of Technology
Consulting Editor

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

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

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

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

FinGame Online 5.0

Case Studies in Finance: Managing for
Corporate Value Creation
Seventh Edition

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

Cornett, Adair, and Nofsinger
M: Finance
Third Edition

Cases in Finance
Third Edition

Grinblatt (editor)
Stephen A. Ross, Mentor: Influence through

Grinblatt and Titman
Financial Markets and Corporate Strategy
Second Edition

Analysis for Financial Management
Eleventh Edition

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

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

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

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

Behavioral Corporate Finance: Decisions that
Create Value
Second Edition

Bodie, Kane, and Marcus
Essentials of Investments
Tenth Edition

Bodie, Kane, and Marcus
Tenth Edition

Hirt and Block
Fundamentals of Investment Management
Tenth Edition

Jordan, Miller, and Dolvin
Fundamentals of Investments: Valuation and
Eighth Edition

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Running Money: Professional Portfolio
First Edition

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Derivatives: Principles and Practice
Second Edition

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Bank Management and Financial Services
Ninth Edition

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Financial Institutions and Markets
Eleventh Edition

Saunders and Cornett
Financial Institutions Management: A Risk
Management Approach
Ninth Edition

Saunders and Cornett
Financial Markets and Institutions
Sixth Edition

Eun and Resnick
International Financial Management
Eighth Edition

Brueggeman and Fisher
Real Estate Finance and Investments
Fifteenth Edition

Ling and Archer
Real Estate Principles: A Value Approach
Fifth Edition

Allen, Melone, Rosenbloom, and Mahoney
Retirement Plans: 401(k)s, IRAs, and Other
Deferred Compensation Approaches
Eleventh Edition

Personal Financial Planning
Second Edition

Harrington and Niehaus
Risk Management and Insurance
Second Edition

Kapoor, Dlabay, Hughes, and Hart
Focus on Personal Finance: An Active Approach
to Achieve Financial Literacy
Fifth Edition

Kapoor, Dlabay, Hughes, and Hart
Personal Finance
Twelfth Edition

Walker and Walker
Personal Finance: Building Your Future
Second Edition


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corporate finance

Stephen A. Ross
Sloan School of Management
Massachusetts Institute of Technology

Randolph W. Westerfield
Marshall School of Business
University of Southern California

Jeffrey F. Jaffe
Wharton School of Business
University of Pennsylvania

Bradford D. Jordan
Gatton College of Business and Economics
University of Kentucky

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Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2018 by McGraw-Hill
Education. All rights reserved. Printed in the United States of America. Previous editions © 2014, 2011, 2009,
and 2007. 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.

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United States.

This book is printed on acid-free paper.

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ISBN 978-1-259-28990-3
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Library of Congress Cataloging-in-Publication Data

Name: Ross, Stephen A., author.
Title: Corporate finance : core principles & applications / Stephen A. Ross,
Sloan School of Management, Massachusetts Institute of Technology,
Randolph W. Westerfield, Marshall School of Business, University of
Southern California, Jeffrey F. Jaffe, Wharton School of Business,
University of Pennsylvania, Bradford D. Jordan, Gatton College of Business
and Economics, University of Kentucky.
Description: Fifth edition. | New York, NY : McGraw-Hill Education, [2016] |
Series: The McGraw-Hill education series in finance, insurance, and real estate
Identifiers: LCCN 2016035324 | ISBN 9781259289903 (alk. paper)
Subjects: LCSH: Corporations—Finance.
Classification: LCC HG4026 .R6755 2016 | DDC 658.15—dc23 LC record available at

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.


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To our family and friends with love and gratitude.

—S.A.R. R.W.W. J.F.J. B.D.J.

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Stephen A. Ross

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

Randolph W. Westerfield

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 Westerfield
came to USC from the Wharton School, University of Pennsylvania, where he was the chairman
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 finan-
cial policy, investment management, and stock market price behavior.


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Bradford D. Jordan

Bradford D. Jordan is professor of finance and holder of the Richard W. and Janis H. Furst Endowed
Chair in Finance at the University of Kentucky. He has a long-standing interest in both applied
and theoretical issues in corporate finance and has extensive experience teaching all levels of
corporate finance and financial management policy. Professor Jordan has published numerous
articles on issues such as cost of capital, capital structure, and the behavior of security prices. He
is a past president of the Southern Finance Association, and he is coauthor of Fundamentals of
Investments: Valuation and Management, 8th edition, a leading investments text, also published
by McGraw-Hill Education.

Jeffrey F. Jaffe

Jeffrey F. Jaffe has been a frequent contributor to finance and economic literatures in such jour-
nals as the Quarterly Economic Journal, The Journal of Finance, The Journal of Financial and
Quantitative Analysis, The Journal of Financial Economics, and The Financial Analysts Journal. His
best-known work concerns insider trading, where he showed both that corporate insiders earn
abnormal profits from their trades and that regulation has little effect on these profits. He has also
made contributions concerning initial public offerings, the regulation of utilities, the behavior of
market makers, the fluctuation of gold prices, the theoretical effect of inflation on interest rates,
the empirical effect of inflation on capital asset prices, the relationship between small-capitalization
stocks and the January effect, and the capital structure decision.

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It was probably inevitable that the four of us would collaborate on
this project. Over the last 20 or so years, we have been working as
two separate “RWJ” teams. In that time, we managed (much to our
own amazement) to coauthor two widely adopted undergraduate
texts and an equally successful graduate text, all in the corporate
finance area. These three books have collectively totaled more than
31 editions (and counting), plus a variety of country-specific editions
and international editions, and they have been translated into at
least a dozen foreign languages.

Even so, we knew that there was a hole in our lineup at the
graduate (MBA) level. We’ve continued to see a need for a concise,
up-to-date, and to-the-point product, the majority of which can be
realistically covered in a typical single term or course. As we began
to develop this book, we realized (with wry chuckles all around)
that, between the four of us, we have been teaching and research-
ing finance principles for well over a century. From our own very
extensive experience with this material, we recognized that corpo-
rate finance introductory classes often have students with extremely
diverse educational and professional backgrounds. We also recog-
nized that this course is increasingly being delivered in alternative
formats ranging from traditional semester-long classes to highly
compressed modules, to purely online courses, taught both syn-
chronously and asynchronously.

To achieve our objective of reaching out to the many different types
of students and the varying course environments, we worked to
distill the subject of corporate finance down to its core, while main-
taining a decidedly modern approach. We have always maintained
that corporate finance can be viewed as the working of a few very
powerful intuitions. We also know that understanding the “why”
is just as important, if not more so, than understanding the “how.”
Throughout the development of this book, we 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.

Perhaps more than anything, this book gave us the chance to
pool all that we have learned about what really works in a corporate
finance text. We have received an enormous amount of feedback
over the years. Based on that feedback, the two key ingredients that
we worked to blend together here are the careful attention to peda-
gogy and readability that we have developed in our undergraduate

books and the strong emphasis on current thinking and research
that we have always stressed in our graduate book.

From the start, we knew we didn’t want this text to be encyclo-
pedic. Our goal instead was to focus on what students really need to
carry away from a principles course. After much debate and consul-
tation with colleagues who regularly teach this material, we settled
on a total of 21 chapters. Chapter length is typically 30 pages, so
most of the book (and, thus, most of the key concepts and applica-
tions) can be realistically covered in a single term or module. Writing
a book that strictly focuses on core concepts and applications nec-
essarily involves some picking and choosing with regard to both
topics and depth of coverage. Throughout, we strike a balance by
introducing and covering the essentials, while leaving more special-
ized topics to follow-up courses.

As in our other books, we treat net present value (NPV) as the
underlying and unifying concept in corporate finance. Many texts
stop well short of consistently integrating this basic principle. The
simple, intuitive, and very powerful notion that NPV represents the
excess of market value over cost often is lost in an overly mechani-
cal approach that emphasizes computation at the expense of com-
prehension. In contrast, every subject we cover is firmly rooted in
valuation, and care is taken throughout to explain how particular
decisions have valuation effects.

Also, students shouldn’t lose sight of the fact that financial
management is about 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 decisions, and where appropriate, the approximate,
pragmatic nature of financial analysis is made explicit, possible pit-
falls are described, and limitations are discussed.

All chapter openers and examples have been updated to reflect the
financial trends and turbulence of the last several years. In addition,
we have updated the end-of-chapter problems in every chapter.
We have tried to incorporate the many exciting new research find-
ings in corporate finance. Several chapters have been extensively

• In the eight years since the “financial crisis” or “great
recession,” we see that the world’s financial markets
are more integrated than ever before. The theory and
practice of corporate finance has been moving forward
at a fast pace and we endeavor to bring the theory
and practice to life with completely updated chapter


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openers, many new modern examples, completely
updated end of chapter problems and questions. 

• In recent years we have seen unprecedented high
stock and bond values and returns as well as histori-
cally low interest rates and inflation. Chapter 10 Risk
and Return:  Lessons from Market History updates and
internationalizes our discussion of historical risk and
return. With updated historical data, our estimates of
the equity risk premium are on stronger footing And
our understanding of the capital market environment is

• Given the importance of debt in most firms capital
structure, it is a mystery that many firms use no debt.
There is new and exciting research of this “no debt”
behavior that sheds new light on how firms make actual
capital structure decisions. Chapter 15 Capital Structure:
Limits to the Use of Debt explores this new research
and incorporates it into our discussion of Capital

• Chapter 16 Dividends and Other Payouts updates the
record of earnings, dividends, and repurchases for
large U.S. firms. The recent trends show repurchases
far outpacing dividends in firm payout policy. Since
firms may use dividends or repurchases to pay out cash

to equity investors, the recent importance of repur-
chases suggests a changing financial landscape. 

• There are several twists and turns to the calculation
of the firms weighted average of capital. Since the
weighted average cost of capital is the most important
benchmark we use for capital budgeting and repre-
sents a firm’s “opportunity cost,” its calculation is criti-
cal. We update our estimates of Eastman Chemical cost
of capital using readily available data from the Internet
to distinguish the nuances of this calculation. 

Our attention to updating and improving also extended to
the extensive collection of support and enrichment materials that
accompany the text. Working with many dedicated and talented
colleagues and professionals, we continue to provide supplements
that are unrivaled at the graduate level (a complete description
appears in the following pages). Whether you use just the textbook,
or the book in conjunction with other products, we believe you will
be able to find a combination that meets your current as well as
your changing needs.

—Stephen A. Ross
—Randolph W. Westerfield

—Jeffrey F. Jaffe
—Bradford D. Jordan

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Corporate Finance: Core

Principles & Applications
is rich in valuable learning
tools and support to help
students succeed in learning
the fundamentals of financial

Confirming Pages

CHAPTER 5 Interest Rates and Bond Valuation 147

ros89907_ch05_130-164.indd 147 11/10/16 04:18 PM

A convertible bond can be swapped for a fixed number of shares of stock anytime before
maturity at the holder’s option. Convertibles are relatively common, but the number has
been decreasing in recent years.

A put bond allows the holder to force the issuer to buy the bond back at a stated price.
For example, International Paper Co. has bonds outstanding that allow the holder to force
International Paper to buy the bonds back at 100 percent of the face value given that cer-
tain “risk” events happen. One such event is a change in credit rating from investment
grade to lower than investment grade by Moody’s or S&P. The put feature is therefore just
the reverse of the call provision.

Many bonds have unusual or exotic features. One of the most common types is an asset-backed, or securitized, bond.
Mortgage-backed securities were big news in 2007. For several years, there had been rapid growth in so-called sub-
prime mortgage loans, which are mortgages made to individuals with less than top-quality credit. However, a combina-
tion of cooling (and in some places dropping) housing prices and rising interest rates caused mortgage delinquencies
and foreclosures to rise. This increase in problem mortgages caused a significant number of mortgage-backed securities
to drop sharply in value and created huge losses for investors. Bondholders of a securitized bond receive interest and
principal payments from a specific asset (or pool of assets) rather than a specific company. For example, at one point
rock legend David Bowie sold $55 million in bonds backed by future royalties from his albums and songs (that’s some
serious ch-ch-ch-change!). Owners of these “Bowie” bonds received the royalty payments, so if Bowie’s record sales fell,
there was a possibility the bonds could have defaulted. Other artists have sold bonds backed by future royalties, includ-
ing James Brown, Iron Maiden, and the estate of the legendary Marvin Gaye.

Mortgage-backs are the best known type of asset-backed security. With a mortgage-backed bond, a trustee pur-
chases mortgages from banks and merges them into a pool. Bonds are then issued, and the bondholders receive pay-
ments derived from payments on the underlying mortgages. One unusual twist with mortgage bonds is that if interest
rates decline, the bonds can actually decrease in value. This can occur because homeowners are likely to refinance at
the lower rates, paying off their mortgages in the process. Securitized bonds are usually backed by assets with long-term
payments, such as mortgages. However, there are bonds securitized by car loans and credit card payments, among
other assets, and a growing market exists for bonds backed by automobile leases.

The reverse convertible is a relatively new type of structured note. This type generally offers a high coupon rate, but
the redemption at maturity can be paid in cash at par value or paid in shares of stock. For example, one recent General
Motors (GM) reverse convertible had a coupon rate of 16 percent, which is a very high coupon rate in today’s interest rate
environment. However, at maturity, if GM’s stock declined sufficiently, bondholders would receive a fixed number of GM
shares that were worth less than par value. So, while the income portion of the bond return would be high, the potential
loss in par value could easily erode the extra return.

CAT bonds are issued to cover insurance companies against natural catastrophes. The type of natural catastrophe
is outlined in the bond’s indenture. For example, about 30 percent of all CAT bonds protect against a North Atlantic
hurricane. The way these issues are structured is that the borrowers can suspend payment temporarily (or even perma-
nently) if they have significant hurricane-related losses. These CAT bonds may seem like pretty risky investments, but to
date, only three such bonds have not made their scheduled payments, courtesy of the massive destruction caused by
Hurricane Katrina, the 2011 Japanese tsunami, and an unusually active 2011 tornado season.

Perhaps the most unusual bond (and certainly the most ghoulish) is the “death bond.” Companies such as Stone
Street Financial purchase life insurance policies from individuals who are expected to die within the next 10 years.
They then sell bonds that are paid off from the life insurance proceeds received when the policyholders pass away.
The return on the bonds to investors depends on how long the policyholders live. A major risk is that if medical treat-
ment advances quickly, it will raise the life expectancy of the policyholders, thereby decreasing the return to the

Finance Matters
By exploring information found in recent publica-
tions and building upon concepts learned in each
chapter, these boxes work through real-world
issues relevant to the surrounding text.

Confirming Pages

ros89907_ch08_230-261.indd 230 11/10/16 10:29 AM

230 PART 2 Valuation and Capital Budgeting


Making Capital
Investment Decisions
Everyone knows that computer chips evolve quickly, getting smaller, faster, and cheaper.

In fact, the famous Moore’s Law (named after Intel cofounder Gordon Moore) predicts that the

number of transistors placed on a chip will double every two years (and this prediction has

held up very well since it was published in 1965). This growth often means that companies

need to build new fabrication facilities. For example, in 2015, GlobalFoundries announced

that it was going to spend about $646 million to further expand its manufacturing plant in

Saratoga, New York. The expansion at the plant would allow the company to produce more

of its new 14 nanometer (nm) chips. Not to be outdone, IBM announced that it was investing

$3 billion in a public-private partnership with New York State, GlobalFoundries, and Samsung

in an effort to manufacture 7 nm chips, which would be smaller, faster, and consume less

energy than current chips.

This chapter follows up on our previous one by delving more deeply into capital budget-

ing and the evaluation of projects such as these chip manufacturing facilities. We identify the

relevant cash flows of a project, including initial investment outlays, requirements for net

working capital, and operating cash flows. Further, we look at the effects of depreciation and

taxes. We also examine the impact of inflation and show how to evaluate consistently the NPV

analysis of a project.

Please visit us at corecorporatefinance.blogspot.com for the latest developments in the world of corporate finance.

Cash Flows—Not Accounting Income
You may not have thought about it, but there is a big difference between corporate finance
courses and financial accounting courses. Techniques in corporate finance generally use
cash flows, whereas financial accounting generally stresses income or earnings numbers.
Certainly, our text follows this tradition, as our net present value techniques discount cash
flows, not earnings. When considering a single project, we discount the cash flows that
the firm receives from the project. When valuing the firm as a whole, we discount the
cash flows—not earnings—that an investor receives.

Chapter Opening Case
Each chapter begins with a recent real-
world event to introduce students to chap-
ter concepts.

Confirming Pages

ros89907_ch02_019-042.indd 19 11/10/16 09:10 AM

CHAPTER 2 Financial Statements and Cash Flow 19


Financial Statements
and Cash Flow
When a company announces a “write-off,” that frequently means that the value of the compa-

ny’s assets has declined. For example, in July 2015, Microsoft announced that it would write

off $7.6 billion related to its purchase of Nokia’s phone business the previous year. What made

the write-off interesting was that Microsoft had only paid $7.2 billion for the phone business.

The oil business was also hit hard in 2015 as the five largest publicly traded oil companies

working in Wyoming wrote off a combined $41 billion for the first nine months of the year.

These write-offs were due to the declining value of oil production facilities in that state.  

While Microsoft’s write-off is large, the record holder is media giant Time Warner, which

took a charge of $45.5 billion in the fourth quarter of 2002. This enormous write-off followed

an earlier, even larger, charge of $54 billion.

So, did the stockholders in these companies lose billions of dollars when these assets

were written off? Fortunately for them, the answer is probably not. Understanding why ulti-

mately leads us to the main subject of this chapter, that all-important substance known as

cash flow.

Please visit us at corecorporatefinance.blogspot.com for the latest developments in the world of corporate finance.

The balance sheet is an accountant’s snapshot of the firm’s accounting value on a par-
ticular date, as though the firm stood momentarily still. The balance sheet has two sides:
On the left are the assets and on the right are the liabilities and stockholders’ equity. The
balance sheet states what the firm owns and how it is financed. The accounting definition
that underlies the balance sheet and describes the balance is

Assets ≡ Liabilities + Stockholders’ equity [2.1]

We have put a three-line equality in the balance equation to indicate that it must always
hold, by definition. In fact, the stockholders’ equity is defined to be the difference between
the assets and the liabilities of the firm. In principle, equity is what the stockholders would
have remaining after the firm discharged its obligations.

Table 2.1 gives the 2016 and 2017 balance sheets for the fictitious U.S. Composite
Corporation. The assets in the balance sheet are listed in order by the length of time it
normally would take an ongoing firm to convert them to cash. The asset side depends on
the nature of the business and how management chooses to conduct it. Management must
make decisions about cash versus marketable securities, credit versus cash sales, whether

coverage online


Two excellent sources
for company financial
information are finance.
yahoo.com and money.

Core Calculator Skills
This icon, located in the margins of the text near key con-
cepts and equations, indicates that additional coverage is
available describing how to use a financial calculator when
studying the topic. This additional coverage can be found
in a special calculator section, Appendix C.

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Spreadsheet Techniques
This feature helps students to improve their Excel spreadsheet
skills, …

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