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 DGED EDITION
2e Introduction to Corporate Finance

RI
AB

William L. Megginson
University of Oklahoma

Scott B. Smart
Indiana University
This page intentionally left blank
 DGED EDITION
2e Introduction to Corporate Finance

RI
AB

William L. Megginson
University of Oklahoma

Scott B. Smart
Indiana University
 Abridged Edition, Introduction to © 2009 South-Western, a part of Cengage Learning
Corporate Finance, 2E
ALL RIGHTS RESERVED. No part of this work covered by the copyright herein may
William L. Megginson/Scott B. Smart
be reproduced, transmitted, stored or used in any form or by any means graphic,
VP/Editorial Director: Jack W. Calhoun electronic, or mechanical, including but not limited to photocopying, recording,
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Editor-in-Chief: Alex von Rosenberg
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Executive Editor: Mike Reynolds of the 1976 United States Copyright Act, without the prior written permission of
Senior Developmental Editor: Susanna C. Smart the publisher.
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ISBN-13: 978-0-324-65895-8
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1 2 3 4 5 11 10 09 08
 About the Authors

William L. Megginson
Bill Megginson is Professor and Rainbolt Chair in Finance
at the University of Oklahoma. Dr. Megginson is co-
author of the South-Western Cengage Learning MBA
level text Corporate Finance, first published in 2004. He
has published 25 refereed articles in several top academic
journals, including the Journal of Finance, the Journal of
Financial Economics, the Journal of Economic Literature, the
Journal of Financial and Quantitative Analysis, the Journal of
Money, Credit, and Banking, the Journal of Applied Corporate
Finance, and Financial Management. He co-authored a
study documenting significant performance improve-
ments in recently privatized companies that received one
of two Smith Breeden Distinguished Paper Awards for
outstanding research published in the Journal of Finance.
In addition, Dr. Megginson has presented academic papers at over 40 conferences,
as well as at the National Bureau of Economic Research, the Federal Reserve Banks
of New York and Dallas, the OECD, the World Federation of Exchanges, the United
Nations, and the World Bank. He is also a voting member of the Italian Ministry
of Economics and Finance’s Global Advisory Committee on Privatization. Dr.
Megginson has a Ph.D. in finance from Florida State University. He has visited
67 countries and has served as a consultant for the New York Stock Exchange, the
OECD, the IMF, the World Federation of Exchanges, and the World Bank.

Scott B. Smart
Scott Smart has been a member of the finance faculty
at Indiana University since 1990. He is co-author of
Corporate Finance, an MBA level text published by
South-Western Cengage Learning. Dr. Smart has been
recognized as a “Master Teacher” by Business Week con-
tinuously over the last ten years, and has won more than
a dozen teaching awards. He has published articles in
scholarly journals such as the Journal of Finance, the Journal
of Financial Economics, the Journal of Accounting and Eco-
nomics, the Financial Review, and the Review of Economics
and Statistics. His research has been cited by the Wall
Street Journal, New York Post, Business Week, Fortune, and
other major newspapers and periodicals, and he has been
a contributor to CNBC’s Street Signs. His consulting
clients include Intel, Synopsys, and Unext. Dr. Smart has served on local boards of
directors for Habitat for Humanity and other non-profit groups and is a trustee for
the Skyhawk Small Cap mutual fund. Dr. Smart did his undergraduate work at
Baylor University and received his Ph.D. from Stanford University.
v
Preface

As instructors (and former students) we realize that finance can be an intimidating

class, especially for students who struggle with quantitative material. In writing
the first edition of this book, we wanted to change that—to lower the intimidation
factor in our field and to communicate the excitement and relevance that finance
holds for each of us.
Since then we’ve received two types of feedback suggesting that we achieved
our objective of creating a more user-friendly text. First, many users wrote to us
and told us about their positive experiences with the book. Second, the book was
a strong success in the market. Now our challenge is to build on that success and
deliver an even better second edition.
Our major goal in writing this book has been to show students how the con-
cepts they’ve learned from their prerequisite courses—like economics, statistics,
and accounting—directly connect to finance concepts. We hope that they’ll quickly
realize that they already know more than they think they do about finance! We
also want readers to see just how practical the concepts covered in this book are in
everyday life, whether that means at work in professional life or in making per-
sonal financial decisions. To achieve that objective, we have added a new feature
to the second edition that we call Finance in Your Life. Each chapter contains one or
more Finance in Your Life illustrations of how students might encounter one of the
key chapter ideas in their own lives. It is our hope that seeing how the book’s key
ideas might arise in their personal or professional experiences will make the con-
nection between theory and practice much easier.
The skills students learn in this class will assist them in their careers, regardless of
whether they become Chief Financial Officers, Marketing Managers, or Sales Associ-
ates. To illustrate how mastery of this subject will assist them in their careers, we’ve
drawn upon experiences of a broad range of professionals who use finance every
day. We’ve filled the book with relevant and timely examples of how financial issues
arise in the business world: How has the introduction of the iPod affected Apple
Computer and the music industry? What should Apple do with a multi-billion-
dollar cash hoard? Why is an obscure tax court ruling on whether grapevine trellises
should be classified as “agricultural equipment” rather than “land improvements”
of great concern to the wine industry? How did research by two finance professors
lead the CEO of a large company to flee the United States and become a fugitive
fighting extradition from an African nation? Answering these questions requires an
understanding of finance; we explore all of these in depth in our text.
Every student needs some extra explanation or support at different points in
this course. Consequently, a truly outstanding technology package accompanies
this book—a package that will allow students to learn and absorb material at their
own pace. Computer animations review important concepts and techniques to
help them re-examine complex material until they can grasp the ideas with confi-
dence. They can view each animation as many times as needed to understand the
concept or technique. Our own students tell us that these animations, found at the
Smart Finance Web site, www.smartmove4me.com, are more helpful than any other
single feature in the book.

vi
 Preface l vii

Students can also visit the Smart Finance Web site to see a choice of nearly
100 video clips of finance professionals and scholars, each of whom contributes to
the picture of just how often financial issues affect today’s world.
As we were striving to make this the most student-friendly introductory finance
textbook in the market today, we followed a set of core principles when writing
and revising the text and designing the overall support package that accompanies
the book.
1. Pique interest and create relevance for students with real-world examples
that make cutting-edge theories appealing, accessible, and practical. We feel
that it‘s of utmost importance to grab students’ interest and attention from the
beginning of the chapter with an interesting, relevant situation. Every chapter
of this book begins with a story pulled from recent headlines that illustrates a
key chapter concept in an applied setting.
We also strive to provide students with a smooth bridge between theory and
practice by highlighting examples in a feature that we call “Applying the
Model.” These illustrations, many of which use real data from well-known
companies, take concepts and make them easy to understand within an inter-
esting and relevant context.
2. Maximize the pedagogical and motivational value of technology. We have often
experimented with technology packaged with textbooks only to find that the in-
cluded products somehow impeded learning and classroom delivery rather than
facilitated student interest and understanding. At times, the mental investment
required to learn enough about text technology has canceled out students’ ability
to absorb the most important finance concepts. In other cases, students have fo-
cused too much on what a particular technology can do, rather than what it should
do. Some technology add-ons, created by subcontractors rather than the text’s
primary authors, seem to have borne almost no relationship to the text they were
meant to support. And, of course, all too often a technology that we wanted to use
inside or outside of the classroom simply hasn’t worked.
With such experiences behind us, we wanted to develop an integrated tech-
nology package that engages, motivates, and at times entertains students, while
helping them master financial concepts on their own time and at their own pace.
We wanted to use technology to allow students to hear firsthand about exciting
developments in financial research. We wanted students to hear from business
professionals why the material contained in the text is relevant after the final
exam is over. Most of all, as authors of the text, we wanted to take primary
responsibility for creating the technology package to ensure that we seamlessly
integrated technology with the text’s most important concepts and techniques.
Tests with in-residence and online students have generated almost unani-
mous praise for these features. In fact, the most common complaint we
have heard from students is, “Why can’t we see more of this?” Visit
www.smartmove4me.com to see a sample of the rich content that students can
access on the Smart Finance Web site. Access to the Smart Finance Web site is
available to students at no additional cost with each new text.
Some examples of the fully integrated technology include:
• Animated Review Tutorials that explain key concepts;
• Problem-Solving Animations that illustrate numerical solution methods as
well as develop students’ problem-solving intuition;
• Video Clips of well-known American and international academics and fi-
nance practitioners that illustrate the conceptual bases of theory, theory in
practice, and ethical issues that financial professionals routinely face; and
viii l Preface

• Excel® Animations that walk students through problems, or through partic-

ularly challenging aspects of problems, that Excel helps to solve more easily.
3. Provide a truly global perspective. The economic world is shrinking—particularly
with regard to financial transactions. Formerly centrally planned economies are
moving toward market economies. Many developing nations are making rapid
economic progress using markets-based methods. Financial markets play an in-
creasingly important role in the ongoing globalization of business and finance.
Rather than grouping international issues into a chapter or two, we have inte-
grated a global perspective throughout the text. Every chapter has a unique fea-
ture that we call “Comparative Corporate Finance” (CCF) designed to highlight
similarities and differences among corporate finance practices around the world.
4. Consider students’ prerequisites and connect the courses they have taken to
finance. Experienced financial managers consistently tell us that they need peo-
ple who can see the big picture and who can recognize connections across func-
tional disciplines. To help students develop a larger sense of what finance is
about, why it is relevant to their business studies, and to ease their transition
into their own chosen fields, we highlight concepts that most students learn in
their introductory economics, statistics, and accounting courses. We then con-
nect these concepts to finance.
Several video clips early in the book also emphasize connections between finance
and other disciplines. Beginning with what students know and building on that
foundation allows us to use an approach that we have used successfully in our
own teaching for many years. We wanted our book to reflect that teaching philo-
sophy.
Excel® Appendices appear for 12 relevant chapters (Chapters 2–8, 10, 15, 16, 18,
and 19). These appendices explicitly show students how to build Excel spread-
sheets to solve finance problems more easily using modern tools rather than tables
or even calculators. Excel is clearly the tool of choice for finance courses and for
finance professionals today.
Thomson ONE—Business School Edition Problems: Thomson ONE-BSE is an
online database that draws from the industry-leading Thomson Financial’s
data sources, including Disclosure, Datastream, and Securities Data Corpora-
tion databases. Analysts and other finance professionals use this tool every day
to conduct research. To help motivate students to perform basic research and
analysis without creating extra work for the instructor, the authors have writ-
ten end-of-chapter problems that require students to use Thomson ONE-BSE.
Learning Objectives highlight the key ideas of each chapter; they appear at the
beginning of each chapter.
Concept Review Questions conclude each section within chapters and test stu-
dents’ retention of material. These Concept Review Questions tie directly to the
learning objectives that open the chapters.

Text Supplements
Instructor’s Manual. Revised by Robert Puelz of Southern Methodist Univer-
sity, this comprehensive Instructor’s Manual is designed to support novice
instructors and finance veterans alike, and includes chapter overviews, lecture
guides organized by section, enrichment exercises, answers to concept review
 Preface l ix

questions, answers to end-of-chapter questions, and solutions for end-of-chapter

problems.
Test Bank. Revised by Pamela Hall, Western Washington University, the Test
Bank has been expanded for this edition. In addition, each question includes an
AACSB competency designation.
ExamView. ExamView Computerized Testing Software contains all of the ques-
tions in the printed test bank. This program is an easy-to-use test creation software
compatible with Microsoft Windows®. Instructors can add or edit questions, instruc-
tions, and answers and select questions randomly, by number, or by previewing
them on screen. Instructors can also create and administer quizzes online, whether
over the Internet, a local area network (LAN), or a wide area network (WAN).
PowerPoint Slides. PowerPoint slides are available for instructors for enhanc-
ing their lectures. They are available as downloads from the product support Web
site at academic.cengage.com/finance/megginson.
Instructor’s Resource CD-ROM (IRCD). A CD-ROM is available to instruc-
tors and contains electronic versions of all print instructor supplements—
Instructor’s Manual, Test Bank in Microsoft Word and in ExamView, and Power-
Point slides.
www.smartmove4me.com Site. Access to the Web site and study tools is
available to students at no additional cost with each new text. Some examples of
the integrated technology materials include:
• Smart Concepts. These animated concept review tutorials, organized by
chapter, explain key topics step by step, offering students opportunities to re-
view more difficult chapter material at their own pace and at convenient times.
Students can also decide how much or what parts of the review they want
to cover. An icon in the text directs students to www.smartmove4me.com to
explore.
• Smart Solutions. The Smart Solutions feature helps improve students’
problem-solving skills by demonstrating animated solution steps and offering
coaching about how to identify the right technique to apply to particular prob-
lems. An icon in the text directs students to www.smartmove4me.com to explore
Smart Solutions.
• Smart Ideas Videos. Introduce your students to the leading academic re-
searchers behind the theory or concepts you are discussing in class with Smart
Ideas Videos. Each clip runs approximately two to three minutes. Video clips
feature John Graham (Duke University), Robert Schiller (Yale), Elroy Dimson
(London School of Business), Andrew Karolyi (Ohio State University), Kenneth
French (Dartmouth College), and many, many more. An icon in the text directs
students to www.smartmove4me.com to view these short video clips, which in-
structors can also embed in their PowerPoint presentations.
• Smart Practices Videos. Business and industry leaders discuss how they maxi-
mize their companies’ financial performance using cutting-edge practices. These
videos can help show students why corporate finance is a vital topic regardless of
their functional areas. Presidents and CFOs of major corporations, such as Andy
Bryant, CFO of Intel Corp., as well as corporate recruiters, are featured interview-
ees. An icon in the text directs students to www.smartmove4me.com, or instructors
can embed these 2- to 3-minute video clips within their PowerPoint lectures.
• Smart Ethics Videos. These videos show how both academics and business
executives view ethics and the impact that ethical or unethical behavior can
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