Foundations of Corporate Finance

Errata
The following are corrections to minor typos in the …rst edition of the text book: Foun-
dations of Corporate Finance.

Chapter 2
On page 24, Solution 1, the sample mean r should be
P
rt 25 + 40 + 14:3 12:5 66:8
r= = = = 16:7%:
n 4 4
Thus, the investor would require approximately 17% rate of return in order to be
motivated to invest in it.
On page 46, in the variance formula of B, 2B , the second term should be (50-26)2 and
the total should be 1164 (and not 1188). Following this, the number 1188 that appears
in 2P on the same page should be 1164 instead. Please also adjust the portfolio risk,
p , on the same page accordingly.

In Example 14, on page 49, assume that of the existing portfolio is 1% (and not
2%). This was not mentioned in the problem but the calculations are based on this
assumption.

Chapter 3
In Solution 7, page 64, the denominator of the variance and covariance formulas should
be n 1 (and not n): Below is the correct version of this problem:
P
(rA rA ) (rM rM ) 111
cov (rA ; rM ) = = ;
n 1 4
P
(rM rM )2 170
var (rM ) = = ;
n 1 4
111
cov (rA ; rM ) 4
A;M = = 170 = 0:65
var (rM ) 4
Thus,
ErA = rf + A;M (ErM rf )
= 1 + 0:65(4 1)
= 2:95%:
The Sharpe ratio is the ratio of the market excess return over the market volatility;
that is,
(ErM rf )
Sharpe Ratio =
M
4 1 3
= q = = 0:46:
170 6:52
4

1
Chapter 4
In Chapter 4, page 84, Example 28: The …rst line should read: Suppose you are planning
to buy a computer in three years (and not two years).

In Chapter 4, page 90, Problem 11: The …rst line should read: Your landscaping com-
pany can lease a truck for $8200 a year for 6 years (and not 5 years)

Problem 10 on page 95: The investment includes the period between 1900 and 2008
(both inclusive). So, the number of investment years is 109 (and not 108). This is just
a clari…cation; nothing is wrong with the problem itself.

Problem 12 on page 94 is on Canadian mortgages, where interest rates are quoted in

a speci…c way (see the explanation on page 93). Note that one should not confuse this
particular problem with other general problems where you will be asked to compute
EAR knowing APR or vice-versa.

Problem 12 on page 95: The rates given are per-period rates, i.e., AP R=m = 6:2% for
the semi-annual compounding and AP R=m = 6% for the quarterly compounded.

Chapter 5
The current yield is, by de…nition, the coupon payment divided by the bond price
(remark 9 on page 105). But, sometime, the coupon payment, C, is paid semiannually
or quarterly, so we can still compute the per-period current yield as C=m divided by
the bond price as in de…nition 33 on page 105.

Problem 17 on page 115 calculates the current yield as the per-period rate. Please
correct the …rst requirement of the problem to read: What is the per-period current
yield on this bond?

The solution on page 116, number (1) should read the current per-period yield (and
the current yield).

Example 41 on page 126: The company is expected to pay a dividend of $10 at the end
of this year. This statement means that D0 = 10: This is another way of saying that
the last dividend that is known to us is $10. All future dividends are unknown.

Problem 20 on page 128: Same rationale; the last dividend known to us is D0 = $2:50.
There is nothing wrong with the statement. This is just to clarify.

Chapter 6
Remark on Criterion 2 on page 140: The shareholders’ criterion to invest in new in-
vestment projects is such that

RRR > W ACC:

2
 Here RRR is the required rate of return on the entire project. This rate is also known
as the internal rate of return (IRR) on the project. The term IRR is the one that is
commonly used. So, we can restate this criterion as: IRR > W ACC:

Chapter 7
In Chapter 7, we learn three ways to evaluate a project: payback period (PBP), net
present value (NPV), and IRR. Since we use these evaluations methods in general for
any project, the NPV equation on page 156, equation (7.1), has E[CF ], i.e., expected
cash ‡ows, for each year. These cash ‡ows di¤er from one project to another. Hence,
the use of the "E" operator. In particular, if your project is replacing a machine or
buying a new one (same as the type of projects in Chapter 6), then E[CF ] for every
year becomes the operating cash ‡ow (OCF) and the last cash ‡ow in the terminal
year becomes the terminal cash ‡ow (TCF) that we learned in Chapter 6.

Chapter 8
On page 182, Equation (8.9) should read:

Opportunity cost of Equity = id + ( )

The WACC formula on page 181, equation (8.7), is the correct one. The same formula
is reproduced at the bottom of page 182, but it is missing a bracket. This should be
corrected to read:
E L
W ACC = [id + ( )] + ib (1 t)
I I