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were absolutely first-rate in all respects. I appreciate their help along the way.
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Copyright Ivo Welch, 2017. All Rights Reserved.

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1st Edition, “Corporate Finance: An Introduction,” ISBN-10 0321277996.
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2nd Edition, “Corporate Finance,” ISBN-10: 09840049-5-5, ISBN-13: 978-09840049-5-9.
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3rd Edition, “Corporate Finance,” ISBN-13: 978-0-9840049-1-1.
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This book is dedicated to my parents, Arthur and Charlotte Welch,

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my wife Lily, and my three children, Arthur, Leonard and Greta.
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any price. After you have used this book once, you will not want to go back. As far as I know, no
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one who has ever used this book has ever switched back unless forced to do so by a committee.
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This book is also an experiment in pricing. All major economics book publishers believe that
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professors do not care how much their textbooks cost. This book puts this belief to the test: its
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competitors cost $300 plus. This edition remains priced at $60 in print, and it is also available
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for free on the web. (This price is low enough to allow many students to keep this book even
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after they have completed the course.) Of course, professors should adopt this book not because
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of its price, but because it is simply the best corporate finance textbook today, with full instructor
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support materials, including a free course management and equiz website.
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Essential Corporate Finance covers all the topics of the usual corporate finance curriculum.
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However, as noted above, the organizing principle of moving from perfect to imperfect markets
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Part I: Value and Capital Budgeting shows how to work with rates of return and how to decide
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whether to take or reject projects in a perfect market under risk neutrality. Five chapters
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and annuities, capital budgeting, interest rates, uncertainty, and debt and equity in the
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absence of risk aversion.
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risk and expected returns in a perfect market. It first provides a historical backdrop of rates
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realistic. Thus, in this part, two chapters examine the reality of information differences,
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noncompetitive markets, transaction costs, and taxes. The chapters also explain differences
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between efficient and inefficient markets, and between rational and behavioral finance.
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The Companion
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This edition of the book is disciplined in keeping only enough content to fit the essential first
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course in finance. This keeps the book short. Other material—even important material as long
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as it is impossible to cover in a first course—is now in a “Companion” book. This book is also
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available for free. Instructors can also print and distribute individual chapters. Formatting is the
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same as it is in this primary book, but update are only ever other edition or so. The companion
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includes such chapters as “International Finance,” which are a necessary checkbox for AACSB
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accreditation—but which no introductory finance course has ever found time to cover.
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structure patterns in the United States, investment banking and mergers & acquisitions, corporate
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governance, international finance, and options and risk management. It also includes appendices
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real world); Chapter 8 (more explanations for the efficient frontier); and Chapter 10 (certainty
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and the CAPM, and available CAPM alternatives, such as the APT); Chapter 12 (an event study);
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the main text. Finally, the book’s website (book.ivo-welch.info) has a chapter on quantitative
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real option implementation and a provocative chapter on ethics.

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the third to the fourth edition, is now laid out onto the website, book.ivo-welch.info. The website
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PS: Please email any errata to the author. The website will keep an errata page.
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To Struggling First-Course Finance Students
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I would like to warn you ahead of time about one common issue in introductory finance
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classes that may end up frustrating you. This is especially the case if you take your first finance
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course in an MBA program. Chances are that you will find the tempo of the first finance course
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knowledge. (Some also wrongly believe that they already know everything they need to know,
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fail to realize this and study, and are then shocked when they fail the course.)
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Another large fraction has not seen an equation for many years. They may even be less
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prepared now than they were when they graduated from high school. It is a challenge for them
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simply to keep up.
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If you are in the second group, you will initially feel overwhelmed by the class experience.
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(And you will likely not do as well on the early exams—the world is not fair.) My advice to help
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And let me advise patience, practice, and reflection: New knowledge will eventually fall into
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of their classes. (One of my best and most memorable students was a D.J. in Lebanon before she
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joined the MBA program!) Struggling and anxiety along the way are necessary and maybe even
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desirable. Whether you like it or not, some angst will be unavoidable. Tough it out.
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You may become tempted to blame your instructor for your frustrations. But instructors are
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caught in the same circumstances as you are. How would you gear an introductory finance class
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toward the different kinds of students in your class? See, despite the different levels of student
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preparedness, recruiters expect every graduating MBA to have a solid grasp of the finance basics.
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(And they often ask questions that could go right onto the midterm or final.) If there is a magic
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bullet, I have not found it. There are no easy solutions.

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After having lamented our common dilemma, let me not disavow our instructor responsibility:
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We must make the first finance course a surmountable and interesting challenge for all motivated
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students, regardless of background. Every unprepared but willing student must be able to acquire
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even to be liked. In fact, a recent study at the U.S. Air Force Academy has shown that students
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randomly enrolled in classes did better in subsequent courses if their first instructor was less
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generous in grading and less well-liked. If you want to be entertained, skip the finance course
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and listen to TED lectures on pop culture, instead. Finance is not a passive or easy experience.
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May the Force (of this book) be with you!

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PS: If your instructor is not using a syllabus.space site, you can register and work with on the
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Contents vii
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Chapter 1 Introduction 1
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1.1 The Goal of Finance: Relative Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

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1.2 Investments, Projects, and Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

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1.3 Firms versus Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
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Part I Value and Capital Budgeting
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Chapter 2 Present Value 11
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2.1 The Basic Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
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2.2 Loans and Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

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7.
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2.3 Returns, Net Returns, and Rates of Return . . . . . . . . . . . . . . . . . . . . . . . . . . 13
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2.4 Time Value, Future Value, and Compounding . . . . . . . . . . . . . . . . . . . . . . . . 16
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2.5 Present Value, Discounting, and Capital Budgeting . . . . . . . . . . . . . . . . . . . . . 22
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2.6 Net Present Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

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Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
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Chapter 3 Stock and Bond Valuation: Annuities and Perpetuities 37
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3.1 Perpetuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
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3.2 Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
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3.3 The Four Formulas Summarized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

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Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50
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Chapter 4 A First Encounter with Capital-Budgeting Rules 55

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4.1 Net Present Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

1
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4.2 The Internal Rate of Return (IRR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

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4.4 The Payback Capital-Budgeting Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

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4.5 How Do Executives Decide? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

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Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
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Chapter 5 Time-Varying Rates of Return and the Yield Curve 75
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5.1 Working with Time-Varying Rates of Return . . . . . . . . . . . . . . . . . . . . . . . . . 76
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5.2 Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
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5.3 U.S. Treasuries and the Yield Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86
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5.4 Why Does the Yield Curve Usually Slope Up? . . . . . . . . . . . . . . . . . . . . . . . . 95

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Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
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Chapter 6 Uncertainty, Default, and Risk 105

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6.4 Splitting Uncertain Project Payoffs into Debt and Equity . . . . . . . . . . . . . . . . . 123
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Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131
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8.2 Diversification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169
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12.1 Market Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
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Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 381
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16.3 Equity (Stock) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 435
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19.1 What Really Matters? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

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Finance, Economic, and Data Degree Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . 617

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Bon Voyage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 618

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Appendix Chapter. Technical Background 621

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General Mathematical and Statistical Background . . . . . . . . . . . . . . . . . . . . . . . . . 621

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What Finance is All About
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Finance is such an important part of modern life that almost everyone can benefit
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There is one principal theme that carries through all of finance: value. What exactly is a particular
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book is value! Make
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The main reason why you need to estimate value is that you will want to buy objects whose
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values are above their costs and avoid those where the situation is the reverse. Sounds easy? If
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formulas themselves are not sophisticated, there are a lot of them, and they have an intuitive
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economic meaning that requires experience to grasp. But if you managed to pass high-school
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algebra, and if you are motivated, you will be able to handle the math. Math is not the real
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what you should forecast and how you should use your forecasts in the best way, but it mostly
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were easy, a computer could take over this job. But this will never happen. Valuation will
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Toyota Camry, this is not too difficult. There are many other 2013 Toyota Camries, as well as
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2012 Toyota Camries, 2014 Toyota Camries, and 2013 Honda Accords, that you can readily buy.
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Would it be easier to estimate the value of your car if shipping and repainting cars were free?
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close comparable objects than to objects that are very different. In the real world, some objects
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5. The Chrysler Building in New York
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The most basic object in finance is the project. As far as finance is concerned, every project 1
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investment or expense or cost) and are followed by a series of later cash inflows (payoffs or
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including opportunity costs
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revenues or returns). It does not matter whether the cash flows come from hauling garbage
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or selling Prada handbags. Cash is cash. However, it is important that all costs and benefits
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are included as cash values. If you have to spend a lot of time hauling trash, which you find
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distasteful, then you have to translate your dislike into an equivalent cash negative. Similarly, if
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The discipline of finance takes over after all positives and negatives (inflows and outflows) from
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the project “black box” have been translated into their appropriate monetary cash values.
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The Joy of Cooking: Positive Prestige Flows and Restaurant Failures
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In New York City, two out of every five new restaurants close within one year. Nationwide, the best estimates suggest that
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about 90% of all restaurants close within two years. If successful, the average restaurant earns a return of about 10% per
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year. One explanation as to why so many entrepreneurs are continuing to open up restaurants, despite seemingly low
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financial rates of return, is that restauranteurs enjoy owning a restaurant so much that they are willing to buy the prestige
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of owning one. If this is the case, then to value the restaurant, you must factor in how much the restauranteur is willing to
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pay for the prestige of owning it, just as you would factor in the revenues that restaurant patrons generate.
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sales, marketing, payables, working capital, competition, and so on—are unimportant. On the
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and how they could change in the future.

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Projects need not be physical. For example, a company may have a project called “customer
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relations,” with real cash outflows today and uncertain future inflows. You (a student) can be
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viewed as a project: You pay for education (a cash outflow) and will earn a salary in the future
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(a cash inflow). If you value the prestige that the degree will offer, you should also put a cash
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value on it. Then, this too will count as another cash inflow. In addition, some of the payoffs
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from education are metaphysical rather than physical. If you like making friends in school or if
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knowledge provides you with pleasure, either today or in the future, then education yields a
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value that should be regarded as a positive cash flow. (The discipline of finance makes it easy on
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itself by asking you to put a hard cash value number on these or any other emotional factors.)
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Of course, for some students, the distaste of learning should be factored in as a cost (equivalent
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cash outflow)—but I trust that you are not one of them. All such nonfinancial flows must be
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In finance, a firm is viewed as a collection of projects. This book assumes that the value of a
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firm is the value of all its projects’ net cash flows, and nothing else. Actually, the metaphor can
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projects. also extend to a family. Your family may own a house, a car, have tuition payments, education
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There are two important specific kinds of projects that you may consider investing in—bonds
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becoming an owner. You can think of buying a bond as the equivalent of lending money to the
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issuer. In effect, a bondholder is just a creditor. For example, a firm may sell a lender a $100
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bond in exchange for a promised payment of $110 next year. (If the firm were to perform poorly,
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the bond would have to be paid off first, so it is less risky for an investor than the firm’s equity.
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However, it has limited upside.) In addition, the firm usually has other obligations, such as
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money that it has to pay to its suppliers (called “payables”). Together, if you own all outstanding
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claims on the firm, that is, all obligations and all stock, then you own the firm. This logic is not
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Entire Firm = All Outstanding Stocks + All Outstanding Liabilities
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firm then does its business and hopefully earns money. It does not need to pay out immediately
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Yet another way to look at the firm is to recognize that you will receive all the net cash flows
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the firm’s net cash flows, which must be equal to the firm’s net payouts. All of these equalities
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of financing—but for now, you can consider both debt and equity to be just simple investment
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bonds.
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projects: You put money in, and they pay money out. For many stock and bond investments
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that you can buy and sell in the financial markets, it is reasonable to assume that most investors
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enjoy very few, if any, non-cash-based benefits (such as emotional attachment).

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So what is the difference between the two main introductory finance courses, one often called
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Corporate Finance, the other Investments? The first is primarily about the supply of assets to
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markets. It is about investors who want to decide how to allocate their money across many
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make good investments for their portfolios. Thus, the two courses have a fair amount of overlap.
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This book is primarily about teaching concepts that apply to firms. In particular, if you are reading
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The same logic that applies to your Camry applies to corporate projects in the real world.
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Relative valuation often
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money you could earn if you invested your money instead in the bank or the stock market. If you
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know whether you should build it or not. But not all projects are easy to value in relative terms.
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global warming, or of terraforming Mars to make it habitable for humans? There are no easy
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firms should take all projects that add value (in an absolute sense). Later on, you will learn
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want. Therefore, one of the basic premises of finance is that owners expect their managers to
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owners want—value
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maximize the value of the firm. You will learn that, in a perfect world, managers always know maximization!?
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how to do this. However, in the world we live in, this can sometimes be difficult. How should a
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great opportunities in selling green tea, yet others believe the firm should build warships, yet
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others believe the firm should just put all the money into the bank, and yet others believe the
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firm should return all their money to them? These are among the more intriguing problems that
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Ethical dilemmas.
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concerns, most of which are beyond the scope of this book. But let me mention one anyway.
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only within ethically appropriate boundaries. Thus, some will argue that it is the role of public
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of the corporation to abstain from selling them. If nothing else, they argue, if your corporation
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does not sell them, someone else almost surely will. (You can see this as a framework to help you
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understand corporations, not a normative opinion on what the moral obligations of companies
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laws are often passed by legislators who receive donations from tobacco corporations. (Indeed,
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public institutions are intentionally set up to facilitate such two-way “communications.”) What
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Fortunately, you first need to learn about value maximization before you are ready to move
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on to these tougher questions. For the most part, this book sticks with the view that value
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maximization is the corporation’s main objective. This is not to endorse it, but to contemplate
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Q 1.4. Can you use the “law of one price” in your decision of whether to take or reject projects?
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Q 1.5. What is the main objective of corporate managers that this book assumes?
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Keywords
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Bond, 4. Cash flow, 3. Claim, 4. Corporate Finance, 4. Cost, 3. Debt, 4. Demand, 4. Equity, 4. Expense, 3.
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Firm, 4. Investment, 3. Investments, 4. Law of one price, 2. Payoff, 3. Project, 3. Return, 3. Revenue, 3.
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Stock, 4. Supply, 4. Valuation, 1.
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Q 1.1 Here are my own judgment calls. closest alternative—which would be rebuilding it elsewhere.
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This may or may not be easy.

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1. Easy. There are many foreign currency transactions, so you

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can easily figure out how many U.S. dollars you can get for
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have good comparables for the individual components (build-

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sites, e.g., FINANCE (http://finance.yahoo.com).

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center like Manhattan, which means that it may be difficult to

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2. Depends. Some paintings are easier to value than others. For

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example, Warhol painted similar works repeatedly, and the 5. The Chrysler Building would be relatively easy to value. There
17
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price of one may be a good indication for the price of others. are many similar buildings that have changed hands in the
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For other paintings, this can be very hard. What is the value
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last few years.

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3. The Washington Monument is more than just the value of its the candidate and locale.
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probably not that much harder. Stamp collectors know and ment in order to help species. The Yangtze river dolphin,
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usually publish the prices at which the same stamps have however, just recently became extinct, primarily due to hu-
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traded in the past years. man activity. What is the value of this loss? Unfortunately, we
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don’t have good comparables.
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(
Q 1.2 Definitely yes. Foregone salary is a cost that you are bear-
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as a collection of cash flows, similar to other “walking cash
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flows,” but doing so is highly error-prone. Nevertheless, having firms regularly do so. As to (partly) nonmonetary benefits, there
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ing no other opportunities, this is how insurance companies
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is the reputation that the degree bestows on you, the education that
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attach a value to life in court. You may consider yourself more betters you, and the pleasure that excessive beer consumption gives
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unique and irreplaceable. Still, you can infer your own value you (if applicable).
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for your life by figuring out how willing you are to take the
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Q 1.3 Inflows: Value of implicit rent. Capital gain if house appre-

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risk of losing it—e.g., by crossing the street, snowboarding, or
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motorcycling. I have also read that doctors work out what the
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costs. Real estate tax. Uninsured potential losses. Capital loss if
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value of all the proteins in your body are, which comes out to
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house depreciates. And so on.
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be many million dollars. Physicists, on the other hand, break
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Q 1.4 Often, absolutely yes. Indeed, the law of one price is the
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down the proteins further and come up with an estimate that
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foundation upon which all project choice is based.
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End of Chapter Problems
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Q 1.6. What is the law of one price? Q 1.9. A degree program costs $50,000 in total expenses:
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Moreover, the university pays $20,000 of the $30,000 tu-
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po ition in salary to your instructors. Because being in the
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program is so much fun, you would be willing to pay a
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Q 1.8. What is the difference between the value of the firm
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and the sum of the values of all outstanding obligations

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The Mother of All Finance
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We begin with the concept of a rate of return—the cornerstone of finance. You can
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Investors make up just one side of the financial markets. They give money today
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inflows and outflows—into their equivalent present values today. Adding in the cash
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2.2 Loans and Bonds
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The material in this chapter is easiest to explain in the context of bonds and loans. A loan is the
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Finance jargon: interest,
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loan, bond, xed income,
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times in the future (the final one called maturity), usually in exchange for cash upfront today.
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money comes out. You could slap the name “corporate project” instead of “bond” on the cash
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flows in the examples in this chapter, and nothing would change. In Chapter 5, you will learn
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rates. One difference between an interest payment and a noninterest payment is that the
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Who were the world’s first financiers? Candidates are the Babylonian Egibi family (7th Century BCE), the Athenian Pasion
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popular—a fact that readers of the New Testament or the Koran already know. In medieval Europe, Genoa was an early
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innovator. In 1150, it issued a 400-lire 29-year bond, collateralized by taxes on market stalls. By the 15th Century, the first
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true modern banks appeared, an invention that spread like wildfire throughout Europe.elc n) The Economist, Jan 10, 2009
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Interest Rates over the Millennia
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Historical interest rates are fascinating, perhaps because they look so similar to today’s interest rates. Nowadays, typical
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interest rates range from 2% to 20% (depending on the loan). For over 2,500 years—from about the 30th century B.C.E.
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to the 6th century B.C.E.—normal interest rates in Sumer and Babylonia hovered around 10–25% per annum, though 20%
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to about 8% by the turn of the millennium. Interest rates in ancient Egypt tended to be about 10–12%. In ancient Rome,
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interest rates started at about 8% in the 5th century B.C.E. but began to increase to about 12% by the third century A.C.E.
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continental Europe hovered around 10-20% (50% in England). By the Renaissance (16th Century), commercial loan rates
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to 6–10% in the first half, and to 3–6% in the second half (and mortgage rates were even lower). Most of the American
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Homer and Sylla, A History of Interest Rates
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Many investments have interim payments. For example, many stocks pay interim cash
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the amount received in interim payments. It is the dividend or coupon or rent, here $5. When it
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capital gain and still have a positive rate of return. For example, a bond that costs $500, pays a
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Most of the time, people (incorrectly but harmlessly) abbreviate a rate of return or net return
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coupon yield (the percent payout that a stock or a bond provides). If you say that the yield on
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your stock was 5%, then some listeners may interpret it to mean that you earned a total rate
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Sect. 5.2, Pg.82.
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Interest rates should logically always be positive. After all, you can always earn 0% if you
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[Nominal] interest is
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keep your money under your mattress—you thereby end up with as much money next period as
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[usually] nonnegative.
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you have this period. Why give your money to someone today who will give you less than 0%
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(less money in the future)? Consequently, interest rates are indeed almost always positive—the
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rare exceptions being both bizarre and usually trivial.
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Here is another language problem: What does the statement “the interest rate has just
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Basis points avoid an

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increased by 5%” mean? It could mean either that the previous interest rate, say, 10%, has
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just increased from 10% to 10% · (1 + 5%) = 10.5%, or that it has increased from 10% to 15%.
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language: 100 basis points
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Because this is unclear, the basis point unit was invented. A basis point is simply 1/100 of a
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percent. If you state that your interest rate has increased by 50 basis points, you definitely mean
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that the interest rate has increased from 10% to 10.5%. If you state that your interest rate has
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increased by 500 basis points, you definitely mean that the interest rate has increased from 10%
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to 15%.
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100 basis points constitute 1%. Somewhat less common, 1 point is 1%.
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Points and basis points help with “percentage ambiguities.”

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Q 2.3. An investment costs $1,000 and pays a return of $1,050. What is its rate of return?
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Q 2.4. An investment costs $1,000 and pays a net return of $25. What is its rate of return?
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Q 2.6. You buy a stock for $40 per share today. It will pay a dividend of $1 next month. If
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you can sell it for $45 right after the dividend is paid, what would be its dividend yield, what
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return?
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Q 2.7. By how many basis points does the interest rate change if it increases from 9% to 12%?
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Q 2.8. If an interest rate of 10% decreases by 20 basis points, what is the new interest rate?
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2.4 Time Value, Future Value, and Compounding
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Because you can earn interest, a given amount of money today is worth more than the same
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amount of money in the future. After all, you could always deposit your money today into the
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bank and thereby receive more money in the future. This is an example of the time value of
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money, which says that a dollar today is worth more than a dollar tomorrow. This ranks as one
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of the most basic and important concepts in finance.
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The Future Value of Money
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How much money will you receive in the future if the rate of return is 20% and you invest $100
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Here is how to calculate
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today? Turn around the rate of return formula (Formula 2.1) to determine how money will grow
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future payoffs given a rate

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over time given a rate of return:

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of return and an initial
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investment.
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$120 – $100
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Formula 2.1, Pg.14.
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The $120 next year is called the future value (FV) of $100 today. Thus, future value is the value
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FV and PV, you could also have written the above formula as
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Please note that the time value of money is not the fact that the prices of goods may change
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Sect. 5.2, Pg.82. between today and tomorrow (that would be inflation). Instead, the time value of money is
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Q 2.9. A project has a rate of return of 30%. What is the payoff if the initial investment is $250?
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Compounding and Future Value

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Now, what if you can earn the same 20% year after year and reinvest all your money? What
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Interest on interest (or
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would your two-year rate of return be? Definitely not 20% + 20% = 40%! You know that you
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rate of return on rate of
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Co Ma nan
return) means rates cannot will have $120 in year 1, which you can reinvest at a 20% rate of return from year 1 to year 2.
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be added.
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(
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This $144—which is, of course, again a future value of $100 today—represents a total two-year
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rate of return of
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$144 – $100 $144
2
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r2 = = – 1 = 44%
a
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$100 $100
on
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C2 – C0 C2
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This is more than 40% because the original net return of $20 in the first year earned an additional o
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$4 in interest in the second year. You earn interest on interest! This is also called compound
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interest. Similarly, what would be your 3-year rate of return? You would invest $144 at 20%,
an
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which would provide you with
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C3 = $144 · (1 + 20%) = $144 · 1.2 = $100 · (1 + 20%)3 = $100 · 1.23 = $172.80
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C0 · (1 + r)3
2
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Your 3-year rate of return from time 0 to time 3 (call it r3 ) would thus be
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The “one-plus” formula.

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1
,
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$172.80 – $100 $172.80
p
r3 = – 1 = 72.8%
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$100 $100
0
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W
= =
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This formula translates the three sequential 1-year rates of return into one 3-year holding rate
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or
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of return—that is, what you earn if you hold the investment for the entire period. This process
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is called compounding, and the formula that does it is the “one-plus formula”:
,
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Co Ma nan We
)
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r
.
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e
4
on
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4
nc lch
i
(1 + 72.8%) = (1 + 20%) · (1 + 20%) · (1 + 20%) nc
(
F
h
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v
o
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0
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t
t
(1 + r3 ) (1 + r) · (1 + r) · (1 + r)
. I dit
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or, if you prefer it shorter, 1.728 = 1.23 .

7.
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Exhibit 2.1 shows how your $100 would grow if you continued investing it at a rate of return
1
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of 20% per annum. The function is exponential—that is, it grows faster and faster as interest
0
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earns more interest.

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rate of return:
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(1 + rt ) = (1 + r)t = (1 + r) · (1 + r) ··· (1 + r)
| {z } | {z } | {z } | {z }
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Multiperiod Holding Current 1-Period Next 1-Period Final 1-Period
t
Multiperiod Holding
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Rate of Return Rate of Return

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The first rate is called the spot rate because it starts now (on the spot).
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The compounding formula is so common that you must memorize it.

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20 4th
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2
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Another example of a
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an investment project that costs $212 today and earns 10% each year for 12 years will yield an
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payoff computation.
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ra
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1
an
overall holding rate of return of

M
17
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7. h Ed orat 017
r12 = (1 + 10%)12 – 1 = (1.112 – 1) ≈ 213.8%

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or
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(1 + r)t – 1 r12
Fi
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=
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rp
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Your $212 investment today would therefore turn into a future value of
e
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Another random document with
no related content on Scribd:
Condition of repair.
The premises are in good repair.
Biographical notes.
In 1778 John Boldero was in occupation of the premises. His name
appears in the ratebooks until 1791, when it is replaced by that of Mrs.
Boldero.
The Council’s collection contains:—
[767]Sculptured panel of chimneypiece in entrance hall (photograph).
[767]Ornamental plaster ceiling in front room on first floor
(photograph).
XCII.–XCIII.—Nos. 68 and 84, GOWER
STREET.
Ground landlord and lessees.
Ground landlord, His Grace the Duke of Bedford, K.G. The
lessee of No. 68 is Miss Janet McKerrow.
General description and date of
structure.
Gower Street was formed at the same time as Bedford Square,
and many of the houses on the west side as well as some on the east
still present their original fronts.
No. 68, Gower Street, is provided with a bold and simple
wood door case (Plate 106) of excellent proportions, with Roman
unfluted Doric columns and ornamental fanlight. It is a very good
example of late 18th-century design.
The door case (Plate 106) to No. 84, Gower Street, was of
simple and tasteful design, well adapted for its purpose, and typical
of many others in the neighbourhood.
Condition of repair.
No. 68, Gower Street, is in good repair.
No. 84 was demolished in 1907.
Biographical notes.
The occupants of these two houses during the 18th century were,
according to the ratebooks:
No. 68. No. 84.

1787–93. Thos. Gatteker. 1789–1800. Sir John Scott.
1794–97. T. C. Porter.
1797– Mrs. Peters.
In the Council’s collection are:—
No. 46, Gower Street. Doorcase (photograph).
No. 63, Gower Street. Exterior (photograph).
[768]No. 68, Gower Street. Doorcase (photograph).
[768]No. 84, Gower Street. Doorcase (photograph).
XCIV.—NORTH and SOUTH CRESCENTS and
ALFRED PLACE (Demolished).
The sites of North and South Crescents and Alfred Place,

together with the corresponding portion of the east side of
Tottenham Court Road, belong to the City of London Corporation,
and form a part of the property of which some of the proceeds are by
the Act 4 and 5 William IV., cap. 35 (private), devoted to the upkeep
of the City of London School.
For many years before the passing of the Act an annual sum of
£19 10s. had been paid by the Corporation, out of the rents of certain
lands usually called the estates of John Carpenter, towards the
education and clothing of four boys. These estates were popularly
identified with certain properties in Thames Street, Bridge Street,
Westcheap and Houndsditch, and the North and South Crescents
area in St. Giles-in-the-Fields. Unfortunately, no direct connection
can be traced between the last mentioned property and John
Carpenter, who died about 1441.
It seems probable, however, that this part of the City estates
had a different origin.
In 1567 Lord and Lady Mountjoy sold to Sir Nicholas Bacon
the tithes of two closes in Bloomsbury, known as the Great Close of
Bloomsbury, containing 45 acres, and Wilkinson’s Close, containing
4 acres, together with a third close, having an area of 5 acres, and
being then or lately in the tenure of John Hunt.[769] The tithes are
mentioned in the account of the division of the property of St. Giles’s
Hospital[770] as falling to the share of Katherine Legh (afterwards
Lady Mountjoy), but no reference occurs to the third close, which
nevertheless was most probably obtained at the same time. In 1574
an exchange of land was effected between Sir Nicholas Bacon and Sir
Rowland Hayward and other City dignitaries, whereby the latter
acquired the five-acre close in question.[771] The deed relating to the
exchange does not appear to have been enrolled, and consequently
no particulars are available as to the property which was transferred
to Sir Nicholas Bacon.
The earliest record in the possession of the Corporation
relating to the estate in St. Giles is contained in a rental of 1667,[772]
“The Rentall of the Lands and Tenements, sometimes of Mr. John
Carpenter, sometimes Town Clarke of the Citty of London,” and is as
follows: “Margaret the Relict and Executrix of Richard Reede, late
Margaret Pennell, for a Close with the appurtenances cont. by
estimacon five acres, more or lease, and being in the Parish of St.
Giles-in-the-Fields to him demised for 61 years from Lady-day, 1652,
at £4.” Two other properties included in the rental are described as
having been taken by the Corporation in exchange from Sir Nicholas
Bacon, but it is unfortunate that no such statement is made with
regard to the 5–acre close, as such would have prevented any doubt
as to its identification. Nevertheless, scarcely any doubt is possible.
The rental of 1667 shows that the John Carpenter estate included
property acquired by way of exchange from Bacon, and the
presumption of the identity of the 5–acre close contained in that
exchange with the 5–acre close leased to Richard Reede in 1652 is
practically overwhelming. Moreover, it is difficult to see with what
other land the close could possibly be identified. It is quite certain
that it was not in that part of the parish of St. Giles which lay to the
south of Bloomsbury Manor, for there was in that direction no 5–
acre field, of which the history, as detailed in this volume, does not
preclude the possibility of its being identified with the close in
question. It is moreover fairly obvious that the close could not have
been actually included in the Manor of Bloomsbury, since it was in
the hands of Mountjoy.
We are thus almost bound to identify the latter with the North
and South Crescents estate, which, with one exception (Cantelowe
Close), is the only St. Giles property in the neighbourhood not in the
manor of Bloomsbury.
It may, therefore, be assumed that the connection of the land
with the Carpenter Estate only dates from 1574, and that it was
obtained by the trustees of that estate in exchange for other property.
The land remained unbuilt on until the estate was laid out
early in the 19th century. Although the houses were of no
architectural merit, the plan is by no means uninteresting. It consists
of Alfred Place running parallel with Tottenham Court Road, with a
connecting cross road at either end, crescents being formed in these
opposite the north and south ends of Alfred Place.
It is probable that George Dance, the younger, who was City
Architect at the time, modified his idea for the improvement of the
Port of London in the preparation of this design.[773] The former
scheme is embodied in a coloured engraving[774] by William Daniell,
published in 1802.[775]
All the houses have recently been demolished.
In the Council’s collection are:—
North Crescent—General view (photograph).
South Crescent—General view (photograph).
XCV.—HOUSE IN REAR OF No. 196,
TOTTENHAM COURT ROAD.
The land immediately to the north of the City estate was

formerly a field known as Cantelowe Close. In an inquisition held on
20th May, 1639,[776] it was found that John, Earl of Clare,[777] had died
in possession of, inter alia, a parcel of land in the parish of St. Giles,
called “Cantlowe Close,” containing seven acres.[778] The land seems
to have continued in the Holles family until the death of John Holles,
Duke of Newcastle, in 1711, and then to have passed with most of the
latter’s possessions to his nephew, Thomas Pelham-Holles,
afterwards (1715) Duke of Newcastle, for the plan of the new road
from Paddington to Islington which appeared in the London
Magazine for 1756 marked the field to the north of “The City Lands”
as the “Duke of Newcastle’s.” In 1772 the Duke of Newcastle sold to
the Duchess of Bedford and others, trustees for the late Duke, “all
that close or parcell of ground, scituate in the parish of St. Pancras,
[779]
commonly called ... Cantelowe Close, containing nine acres and a
half or thereabouts.”[780]
In 1776 the trustees granted to William Mace, carpenter, a
lease for 78 years of a portion of the ground “in consideration of the
great expense he hath been at in erecting a farmhouse on part of a
field known as Cantelowe Close, and that he, the said William Mace,
shall build proper and convenient sheds and other outhouses for the
accommodation of 40 cows at the least.”[781] It is therefore clear that
the house was built in or shortly before 1776.
It stood about 150 feet east of Tottenham Court Road. The
exterior (Plate 107) was of stock brickwork, with red brick window
heads. The entrance doorcase was of wood, and above were two
tablets showing that formerly the parish boundary between St. Giles
and St. Pancras passed through the house.
The interior had a decorated wood and composition
chimneypiece (Plate 107) in the north front room on the first floor.
The premises were demolished in 1914.
The Council’s collection contains:—
[782]East front (photograph).
[782]Chimneypiece in front room on first floor (photograph).
INDEX OF NAMES AND TITLES.
Abercorn, James Hamilton, 2nd Earl of, 102

Adam Brothers, 151
Alan, 107
Aldewych, 23, 107
Aldewych (Oldwych) Close, 34, 35, 37, 42, 43, 93, 94, 100, 125
Aldewych Cross, 23
Alfred Place, 186
Allen, John, 3n
Allen, Thomas, 108
Allington, Lady, 102
Allington, Lord, 102n
All Saints’ Church, West Street, 115–116
Almshouses in Monmouth Street, 138
Alsopp, Henry, 18
Ampthill, Henry, 109
Ampthill, John, 109n
Angel, The, 122, 125
Angell, Robert, 13, 14
Antelope Inn, 3
Apsley, Henry, Lord (afterwards Earl Bathurst), 149
Apsley, John, 6, 8n
Apsley, Peter, 6, 7
Archer, J. W., 45, 48, 105
Ardowin, John, 115
Arne, Thomas, 89
Arne, Thomas Augustine, 89
Arthur, John, 92
Arthur Street, 145
Arundell, Thomas Howard, Earl of, 44
Arundell, Thomas, 1st Baron Arundell of Wardour, 50
Ashburnham, Francis, 119n
Ashley, Sir Anthony, 7, 9n
Ashley, James, 76, 77
Ashley, Mrs. (formerly Worlidge), 77
Ashlin Place (formerly Paviors Alley), 106, 108
Aspin, William, 89
Aston, Coston, 56
Aubigny, Seigneurs d’ (See Stuart.)
Auchinleck, Alexander Boswell, Lord, 57
Aynscombe, Lily, 84
Back garden, Weld Street, 95n

Bacon, Sir Nicholas, 186, 187
Bacon’s Hotel, Great Queen Street, 84
Bagford, John, 38, 44
Baguley, Mr., 86, 87
Bailey, Anthony, 3n, 9n
Bailey, E. H., 62
Bailey, Jas., 164, 167
Bailie, Jas., 179
Bainbridge (Baynbrigge), Jane, 145n
Bainbridge, Henry, 145
Bainbridge Street, 145
Baines, —, 84
Baker, Ric., 103n
Baker, William, 139
Baltimore (Battimore), Lord, 95, 96
Baltimore, Lady, 96
Banks, Sir John, 7
Banks, Sir Ralph, 7, 8
Bannister, John, 104
Banqueting Hall, Freemasons’ Tavern, 63
Banson, —, 66
Baptist Chapel, Little Wild Street, 99
Barber, Ann, 110
Barber, Thomas, 110
Barber, William, 110
Barbor (alias Grigge), John, 145
Barker, John Raymond, 180
Barker, Thos., 7n
Barkstead, John, 120
Barnard, William, 11n
Barnett, Thomas, 28n
Barnfather, John, 133
Barnfather, Mary, 134
Barnfather, Robert, 134
Baron, John, 125
Barrington, Sir Thos., 39
Bath, Countess of, 75
Bathurst, Henry, 2nd Earl of, 149
Baxter, Nathaniel, 139
Bear, The, Broad Street, 19, 107, 108, 125
Bear Brewhouse, 108n
Bear (Bere) Close, 19, 20, 21, 29n, 30n, 125
Bear Croft, 19
Beauclerk, Lady Diana, 149
Beauclerk, Lord Sydney, 149
Beauclerk, Hon. Topham, 149
Beaufort, Henry, Duke of, 75n
Beaufort House, Chelsea, 53
Beavor, Edward, 75
Beavor, Rhoda (formerly Webb), 75
Bedford, Dukes of, 126
Bedford, Francis Russell, Earl of, 23n, 51n
Bedford, Gertrude, Duchess of, 149, 188
Bedford, Herbrand Arthur, 11th Duke of, 147, 148, 149, 150, 151n,
162, 163n
Bedford, John, 4th Duke of, 149
Bedford Square, 147, 150–184
Bedloe, Mr., 97n
Belasyse, Ann, Lady (formerly Lady Ann Powlet), 137
Belasyse, Ann, Lady (daughter of Sir Robert Crane), 137

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Corporate Finance 4th Edition Ivo

Education, Change and Society 4th Edition Anthony Welch

Introduction to corporate finance: managing Canadian

Corporate Finance - European Edition David Hillier

Corporate Finance Fundamentals Stephen A. Ross

Fundamentals of Corporate Finance 10th Edition Brealey

Cases in Corporate Finance 1st Edition Joshipura

Cases in Corporate Finance 1st Edition Joshipura

CFIN 6: Corporate Finance 6th Edition Scott Besley

University of California, Los Angeles

Anderson Graduate School of Management

Copyright Ivo Welch, 2017. All Rights Reserved.

1st Edition, “Corporate Finance: An Introduction,” ISBN-10 0321277996.

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Software: LATEX and R. Fonts: Charter, Bera. Main Font: 10pt.

About the Author

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This book is dedicated to my parents, Arthur and Charlotte Welch,

my wife Lily, and my three children, Arthur, Leonard and Greta.

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Pricing Model (with warts included).

valuation technique of comparables.

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real option implementation and a provocative chapter on ethics.

also offers more information about additional instructor aids.

Anderson Graduate School of Management

University of California, Los Angeles

4th Edition, 2017

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simply to keep up.

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bullet, I have not found it. There are no easy solutions.

May the Force (of this book) be with you!

generic corporate-finance course at http://syllabus.space to test your progress.

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1.1 The Goal of Finance: Relative Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1.2 Investments, Projects, and Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

1.3 Firms versus Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Part I Value and Capital Budgeting

Chapter 2 Present Value 11

2.1 The Basic Scenario . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

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2.2 Loans and Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

2.3 Returns, Net Returns, and Rates of Return . . . . . . . . . . . . . . . . . . . . . . . . . . 13

2.6 Net Present Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Chapter 3 Stock and Bond Valuation: Annuities and Perpetuities 37

3.3 The Four Formulas Summarized . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

Chapter 4 A First Encounter with Capital-Budgeting Rules 55

4.1 Net Present Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

4.2 The Internal Rate of Return (IRR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

4.3 The Profitability Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

4.4 The Payback Capital-Budgeting Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

4.5 How Do Executives Decide? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

5.4 Why Does the Yield Curve Usually Slope Up? . . . . . . . . . . . . . . . . . . . . . . . . 95

Chapter 6 Uncertainty, Default, and Risk 105

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Chapter 7 A First Look at Investments 137

7.1 Stocks, Bonds, and Cash, 1990-2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

7.2 Overview of Equity-Related Market Institutions . . . . . . . . . . . . . . . . . . . . . . . 154

Chapter 8 Investor Choice: Risk and Reward 165

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