Principles of Corporate Finance (14th Edition, International Edition)

Book 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.

That should not sound intimidating. 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 mod-ern finance. If so, you will read first for new ideas, and for an understanding of how finance theory translates into practice. 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 Fourteenth Edition
What has changed in this edition? You will have seen the first change on the cover: Alex Edmans has joined the author team. Alex is a global authority in corporate finance, with particular expertise in corporate gover-nance, responsible business, and behavioral finance—three areas we have significantly bolstered as we will shortly describe. In addition to being a leading researcher, he has substantial practitioner expertise. He has also won a multitude of teaching awards at MIT, Wharton, and London Business School and is particularly noted for the ability to explain complex finance concepts in simple language. He recently gave a year-long Gresham College public lecture series on the principles of finance attended by a diverse audience, from schoolchildren to retirees.

This expansion of the author team has led to a number of important changes. For example, in recent years many observers have questioned companies’ focus on profits and have suggested that managers should promote the interests of all stakeholders rather than simply seeking to maximize shareholder value. The issue is an important one and we have, therefore, added a new chapter, Chapter 20, that discusses these different corporate objectives, how far they conflict, and how a responsible business should behave.

The structure of a firm’s governance is closely related to its objectives. We have therefore moved the material on corporate governance and agency issues to Chapter 19, where it now sits next to the chapter on corporate objec-tives. This chapter has also been substantially rewritten.
Other chapters with major changes include the two chapters on the pricing of risky assets (Chapters 7 and 8). Chapter 7 now focuses on portfolio choice and a stock’s effect on portfolio risk, while Chapter 8 concentrates on asset pricing. This is a clearer separation of topics than in previous editions; we think that it is more logical and helps understanding.
The discussion of market efficiency (Chapter 12) has also undergone substantial revision with additional and updated sections on empirical evidence. The chap-ter also contains an expanded discussion of behavioral finance and the evidence for behavioral biases.
Financial innovation today is being driven by techno-logical developments such as artificial intelligence, big data, and cloud computing. Chapter 13 now includes a new section that reviews seven ways in which financial technology is changing financial practice.

U.S. financial managers work in a global environ-ment 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 international material, including information about the major developing economies, such as China and India. Material on international differences in financing is now integrated in Chapter 14, while Chapter 19 includes a discussion of governance systems around the world.

PEDAGOGICAL CHANGES

Throughout, we have tried to explain the material much more clearly–importantly, without dumbing it down. The style of this edition is more direct and less whim-sical, with terms being precisely defined and key con-cepts made explicit rather than having to be inferred from the narrative. In many cases, the changes consist of some updated data here and a new example there. Often, these additions reflect some recent development in the financial markets or company practice.
We have also changed the introduction to each chapter to include summaries of the content of each of the chap-ter’s sections. We think that this will make it easier for the reader to understand the organization of the chapter and to jump forward to a particular topic of interest. Chapters now also conclude with key takeaway bullet points sum-marizing the chapter’s principal lessons.

Within each chapter we have interspersed a number of new self-test questions that provide an opportunity for readers to pause and check their understanding. Answers to these self-tests are located at the end of the chapter.

The Beyond the Page digital extensions and applications provide additional examples, anecdotes, spreadsheet programs, and more detailed explanations and practice examples of some topics. This extra material makes it possible to escape from the constraints of the printed page by providing more explanation for readers who need it and additional material for those who would like to dig deeper. There are now more than 150 of these apps. They are seamlessly available with a click on the e-version of the book, but they are also readily accessible in the traditional hard copy of the text using the shortcut URLs provided in the margins of relevant pages. Check out mhhe.com/brealey14e to learn more.

Examples of these applications include:

∙ Chapter 2 Would you like to learn more about how to use Excel spreadsheets to solve time value of money problems? A Beyond the Page application shows how to do so.
∙ Chapter 3 Do you need 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 common stock, or learn how to measure convexity?The duration app 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 7 Ever wondered how COVID-19 has affected the risk of stocks in the travel industry? An app provides the answer.
∙ Chapter 12 Want an example of how speculative trading can swamp the actions of arbitrageurs? The app on the explosion in the price of GameStop shares provides one.
∙ Chapter 18 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 22 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 Structure
Each chapter of the book includes an introductory preview, a list of key takeaways, and suggested fur-ther reading. The list of candidates for further read-ing is now voluminous. Rather than trying to include every important article, we largely list survey articles or general books. We give more specific references in footnotes.

In addition to the self-test questions within the chap-ter, each chapter is followed by a set of problems on both numerical and conceptual topics, together with a few challenge problems.
We include a Finance on the Web section in chapters where it makes sense to do so. This section now houses a number of Web Projects, along with new Data Anal-ysis problems. These exercises seek to familiarize the reader with some useful websites and to explain how to download and process data from the web.

The book also contains 12 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 12 parts. Parts 1, 2, and 3 cover valuation and capital investment decisions, including portfolio theory, asset pricing models, and the cost of capital. Parts 4 through 9 cover financing decisions, payout policy and capital struc-ture, corporate objectives and governance, options, debt financing, and risk management. Part 10 covers financial analysis, planning, and working-capital man-agement. Part 11 covers mergers and acquisitions, and corporate restructuring. Part 12 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.