14 Sep The company World Airline System is composed of the routes X and Y, and each route requires 10 aircrafts. Th
The company “World Airline System” is composed of the routes X and Y, and each route
requires 10 aircrafts. These routes can be serviced by three types of aircrafts — A, B, and C.
There are (five) 5 type A aircraft available, 10 type B, and 10 type C. These aircrafts are identical
except for their operating costs, which are as follows:
Annual operating cost ($ millions)
Table (**************)
The aircrafts have a useful life of five years and a salvage value of $1 million.
The aircrafts owners do not operate the aircrafts themselves but rent them to the operators.
Owners act competitively to maximize their rental income, and operators attempt to minimize
their operating costs. Airfares are also competitively determined. Assume the cost of capital is
10%.
a. Which aircraft would be used on which route, and how much would each aircraft be
worth?
b. What would happen to usage and prices of each aircraft if the number of type A
aircrafts increased to 10. 15, or 20?
State any additional assumptions you need to make.
********************
2pages . must get citation from the book flow APA 7 format. get introduction and conclusion
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Problem
The world airline system is composed of the routes X and Y, each of which requires 10 aircraft. These routes can be serviced by three types of aircraft—A, B, and C. There are 5 type A aircraft available, 10 type B, and 10 type C. These aircraft are identical except for their operating costs, which are as follows:
Annual Operating Cost ($ millions)
Aircraft Type Route X Route Y
A 1.5 1.5
B 2.5 2.0
C 4.5 3.5
The aircraft have a useful life of five years and a salvage value of $1 million.
The aircraft owners do not operate the aircraft themselves but rent them to the operators. Owners act competitively to maximize their rental income, and operators attempt to minimize their operating costs. Airfares are also competitively determined. Assume the cost of capital is 10%.
a. Which aircraft would be used on which route, and how much would each aircraft be worth?
b. What would happen to usage and prices of each aircraft if the number of type A aircraft increased to 10?
c. What would happen if the number of type A aircraft increased to 15?
d. What would happen if the number of type A aircraft increased to 20?
State any additional assumptions you need to make.
Step-by-step solution
Equilibrium refers to the state in which the market demand is equal to the market supply. This situation leads to a level where prices are stable.
Comment
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The competitive price is the price of a product based upon the competition. Competitive prices are charged by the business players in similar industry.
Comment
The airline system is composed of two routes, X and Y, and each route requires 10 aircrafts. There are 5 types of A aircraft, 10 types of B and 10 types of C. Useful life is five years and salvage value is $1 million. Cost of capital is 10%.
The operating costs for aircrafts are as follows:
Aircraft Type Annual Operating cost ($ millions)
Route X Route Y
A 1.5 1.5
B 2.5 2
C 4.5 3.5
Comment
Computation of price of Type – A and Price B:
The following are the important issues in computation of price of Type – A and B:
(a) The aircraft will be deployed in a manner that will minimize costs. That is, each aircraft will be used on the route for which it has the greatest competitive advantage.
(b) It will be assumed that Route X is served with five Type – As and five Type – Bs and Route Y is served with five Type – Bs and five Type – Cs.
(c) The balance of Type – C aircrafts will be scrapped.
(d) The maximum price to pay for the aircraft is the additional cost to be incurred if the aircraft is not serviced regularly.
Comment
Formula to calculate present value is as follows:
Comment
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The value of PVIFA can be known from the PVIFA table for 10% at 5th year.
Comment
The present value of the operating costs at 10% cost of capital for five years will be computed as below:
Aircraft Type Annual Operating cost ($ millions)
Route X Route Y
A
B
C
Comment
Computation of cost of using Aircrafts:
Type – A:
This cost must be equal to the cost of using a Type – B aircraft in Route X.
Therefore,
Comment
Type – B:
This cost must be equal to the cost of using a Type – C aircraft in Route Y.
Therefore,
Since the five types of aircrafts are scrapped for $1 million, the price of Type – C aircraft is $1 million.
Calculate the Price of Type – B aircraft as follows:
Comment
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Recommended solutions for you in Chapter 12
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Calculate the Price of Type – A aircraft as follows:
Comment
Therefore, the price of Type – B will be $6.69 million, and that of Type – A is $10.48 million.
Comment
Using the above figures, the solutions will be given as follows:
Question Route
X
Usage
Y Scrap Aircraft value (in $ millions)
A B C
(a) 5A+5B 5B+5C 5C 10.48 6.69 1.00
(b) 10A 10B 10C 10.48 6.69 1.00
(c) 10A 5A+5B 5B+10C 2.90 1.00 1.00
(d) 10A 10A 10B+10C 2.90 1.00 1.00
Comment
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Chapter 12, Problem 10
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Principles of Corporate Finance
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Financial Management
Block, Hirt, and Danielsen Foundations of Financial Management Seventeenth Edition
Brealey, Myers, and Allen Principles of Corporate Finance Thirteenth Edition
Brealey, Myers, and Allen Principles of Corporate Finance, Concise Second Edition
Brealey, Myers, and Marcus Fundamentals of Corporate Finance Ninth Edition
Brooks FinGame Online 5.0
Bruner Case Studies in Finance: Managing for Corporate Value Creation Eighth Edition
Cornett, Adair, and Nofsinger Finance: Applications and Theory Fourth Edition
Cornett, Adair, and Nofsinger M: Finance Fourth Edition
DeMello Cases in Finance Second Edition
Grinblatt (editor) Stephen A. Ross, Mentor: Influence through Generations
Grinblatt and Titman Financial Markets and Corporate Strategy Second Edition
Higgins Analysis for Financial Management Twelfth Edition
Ross, Westerfield, Jaffe, and Jordan Corporate Finance Twelfth Edition
Ross, Westerfield, Jaffe, and Jordan Corporate Finance: Core Principles and Applications Fifth Edition
Ross, Westerfield, and Jordan Essentials of Corporate Finance Ninth Edition
Ross, Westerfield, and Jordan Fundamentals of Corporate Finance Twelfth Edition
Shefrin Behavioral Corporate Finance: Decisions that Create Value Second Edition
Investments
Bodie, Kane, and Marcus Essentials of Investments Eleventh Edition
Bodie, Kane, and Marcus Investments Eleventh Edition
Hirt and Block Fundamentals of Investment Management Tenth Edition
Jordan and Miller Fundamentals of Investments: Valuation and Management Eighth Edition
Stewart, Piros, and Heisler Running Money: Professional Portfolio Management
Sundaram and Das Derivatives: Principles and Practice Second Edition
Financial Institutions and Markets
Rose and Hudgins Bank Management and Financial Services Tenth Edition
Rose and Marquis Financial Institutions and Markets Eleventh Edition
Saunders and Cornett Financial Institutions Management: A Risk Management Approach Ninth Edition
Saunders and Cornett Financial Markets and Institutions Seventh Edition
International Finance
Eun and Resnick International Financial Management Eighth Edition
Real Estate
Brueggeman and Fisher Real Estate Finance and Investments Sixteenth Edition
Ling and Archer Real Estate Principles: A Value Approach Fifth Edition
Financial Planning and Insurance
Allen, Melone, Rosenbloom, and Mahoney Retirement Plans: 401(k)s, IRAs, and Other Deferred Compensation Approaches Twelfth Edition
Altfest Personal Financial Planning Second Edition
Kapoor, Dlabay, and Hughes Focus on Personal Finance: An Active Approach to Help You Develop Successful Financial Skills Sixth Edition
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Walker and Walker Personal Finance: Building Your Future Second Edition
THE MCGRAW-HILL/IRWIN SERIES IN FINANCE, INSURANCE, AND REAL ESTATE
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Richard A. Brealey Professor of Finance
London Business School
Stewart C. Myers Professor of Financial Economics
Sloan School of Management Massachusetts
Institute of Technology
Franklin Allen Professor of Finance and Economics
Imperial College London
THIRTEENTH EDITION
Principles of Corporate Finance
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PRINCIPLES OF CORPORATE FINANCE, THIRTEENTH EDITION
Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2020 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2017, 2014, and 2011. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning.
Some ancillaries, including electronic and print components, may not be available to customers outside the United States.
This book is printed on acid-free paper.
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ISBN 978-1-260-01390-0 MHID 1-260-01390-1
Portfolio Manager: Charles Synovec Product Developer: Noelle Bathurst Marketing Manager: Allison McCabe-Carroll Content Project Managers: Fran Simon and Jamie Koch Buyer: Laura Fuller Design: Matt Diamond Content Licensing Specialist: Ann Marie Jannette Cover Image: Emily Tolan/Shutterstock Compositor: SPi Global All credits appearing on page or at the end of the book are considered to be an extension of the copyright page.
Library of Congress Cataloging-in-Publication Data
Names: Brealey, Richard A., author. | Myers, Stewart C., author. | Allen, Franklin, 1956- author. Title: Principles of corporate finance / Richard A. Brealey, Professor of Finance, London Business School, Stewart C. Myers, Robert C. Merton (1970) Professor of Finance, Sloan School of Management, Massachusetts Institute of Technology, Franklin Allen, Professor of Finance and Economics, Imperial College London. Description: Thirteenth edition. | New York, NY : McGraw-Hill Education, [2020] Identifiers: LCCN 2018040697 | ISBN 9781260013900 (alk. paper) Subjects: LCSH: Corporations—Finance. Classification: LCC HG4026 .B667 2020 | DDC 658.15—dc23 LC record available at https://lccn.loc.gov/2018040697
The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.
mheducation.com/highered
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To our parents.
Dedication
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vi
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⟩ Richard A. Brealey
Professor of Finance at the London Business School. He is the former president of the European Finance Association and a former director of the American Finance Associa- tion. He is a fellow of the British Academy and has served as a spe- cial adviser to the Governor of the Bank of England and director of a number of financial institutions. Books written by Professor Brealey include Introduction to Risk and Return from Common Stocks.
⟩ Stewart C. Myers
Professor of Financial Economics at MIT’s Sloan School of Manage- ment. He is past president of the American Finance Association, a research associate at the National Bureau of Economic Research, a principal of the Brattle Group Inc., and a retired director of Entergy Corporation. His research is pri- marily concerned with the valuation of real and financial assets, corpo- rate financial policy, and financial aspects of government regulation of business. He is the author of influential research papers on many topics, including adjusted present value, rate of return regulation, pricing and capital allocation in insurance, real options, and moral hazard and information issues in capital structure decisions.
⟩ Franklin Allen
Professor of Finance and Econom- ics, Imperial College London, and Emeritus Nippon Life Professor of Finance at the Wharton School of the University of Pennsylvania. He is past president of the American Finance Association, Western Finance Association, Society for Financial Studies, Financial Intermediation Research Society, Financial Management Association, and a fellow of the Econometric Society and the British Academy. His research has focused on finan- cial innovation, asset price bubbles, comparing financial systems, and financial crises. He is Director of the Brevan Howard Centre for Financial Analysis at Imperial College Business School.
About the Authors
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vii
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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.
Does that sound intimidating? It shouldn’t. 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 modern finance. If so, you will read first for new ideas, for an understanding of how finance theory translates into practice, and occasionally, we hope, for entertain- ment. 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 Thirteenth Edition We are proud of the success of previous editions of Principles, and we have done our best to make the thir- teenth edition even better.
Some of the biggest changes in this edition were prompted by the tax changes enacted in the U.S. Tax
Cuts and Jobs Act passed in December 2017. One of the chapters most affected was Chapter 6, which is con- cerned with calculating the present value of capital proj- ects. We describe the major tax changes in that chapter, and we work through an example of a capital budget- ing problem with 100% bonus depreciation and a 21% corporate tax rate. But the U.S. system of immediate expensing of capital expenditures is almost unique. So we also set out examples of the more common systems of straight-line depreciation and double- declining-balance, which is essentially identical to the former U.S. MACRS depreciation.
Another 2017 tax change was the limit imposed on interest tax shields. For companies that are caught by this change, it may no longer make sense to discount cash flows by the weighted average cost of capital. We discuss the implications for company debt policy in Chapter 18. In Chapter 19, we show how adjusted present value can be used in these cases to value companies and projects. Similarly, the cap on interest tax shields complicates the valuation of leases. In Chapter 25, we show that when the cap is operative, leases need to be valued by constructing an equivalent loan. Finally, in Chapter 32, we consider the possible effect on the private-equity market.
The third important change was the switch by the United States to a territorial tax system. This has major implications for tax strategies, which we largely dis- cuss in the chapters on working capital management ( Chapter 30) and mergers (Chapter 31).
U.S. financial managers work in a global environment 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 interna- tional material, including information about the major developing economies, such as China and India. In the current edition, we have continued to augment the interna- tional content. We hope that an understanding of practices in other countries will also lead to a better understanding of the characteristics of one’s own financial system.
Users of previous editions of this book will not find dramatic changes in coverage or in the ordering of top- ics. However, there are a number of chapters that have been thoroughly rewritten. For example, the material on agency issues in Chapter 12 has been substantially revised. Chapter 13 on market efficiency and behavioral
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finance is now fresher and more up to date. Chapter 23 on credit risk focuses more on the practical issues of forecasting default probabilities.
Throughout, we have tried to make the book more up-to-date and easier to read. In many cases, the changes consist of some updated data here and a new example there. Often, these additions reflect some recent devel- opment in the financial markets or company practice.
In the 11th edition, we added digital extensions through our Beyond the Page features, or “apps” as we call them. This extra material can allow us to escape from some of the constraints of the printed page by providing more explanation for readers who need it and additional mate- rial for those who would like to dig deeper. The Beyond the Page features include extra examples and spreadsheet programs, as well as some interesting anecdotes.
There are now more than 150 of these apps. They are all seamlessly available with a click on the e-versions of the book, but they are also readily accessible from the traditional hard copy of the text through the shortcut URLs. Check out mhhe.com/brealey13e to learn more.
Examples of these applications include:
∙ Chapter 1 In Chapter 1, we refer to Bernard Madoff’s ponzi scheme. But this scam pales into insignificance compared with the great Albanian ponzi scheme, which is described in an app.
∙ Chapter 2 Do you need to learn how to use a finan- cial calculator? The Beyond the Page financial cal- culator application shows how to do so.
∙ Chapter 3 Would you like 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 com- mon stock, or learn how to measure convexity? The duration application for Figure 3.2 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 9 How about measuring the betas of the Fama–French three-factor model for U.S. stocks? The Beyond the Page beta estimation application does this.
∙ Chapter 14 Ever wonder why Google split its stock into A and C shares? An app provides the answer.
∙ Chapter 15 Want to now how companies can raise capital by an initial coin offering? There is an app on the topic.
∙ Chapter 19 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 20 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 28 Would you like to view the most recent financial statements for different U.S. companies and calculate their financial ratios? There is an appli- cation that will do this for you.
We believe that the apps offer an opportunity to widen the types of material that can be made available and help the reader to decide how deeply he or she wishes to explore a topic.
We have added end-of-chapter questions, merged what was becoming a false
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