FUNDAMENTALS OF FINANCIAL MANAGEMENT Twelfth Edition
Eugene F. Brigham
UNIVERSITY OF FLORIDA
Joel F. Houston
UNIVERSITY OF FLORIDA
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Fundamentals of Financial Management, 12th edition Eugene F. Brigham, Joel F. Houston Vice President of Editorial, Business: Jack W. Calhoun Editor-in-Chief: Alex von Rosenberg
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PREFACE When the ﬁrst edition of Fundamentals was published 31 years ago, we wanted to provide an introductory text that students would ﬁnd interesting and easy to understand. Fundamentals immediately became the leading undergraduate ﬁnance text, and it has maintained that position ever since. Our goal with this edition was to produce a book and ancillary package that would maintain its lead and set a new standard for ﬁnance textbooks. Important changes in the ﬁnancial environment have occurred since the last edition. New technology and increased globalization continue to transform practices and markets. Continued improvements in communications and transportation have made it easier for businesses to operate on a worldwide basis—a company can be headquartered in New York, develop products in India, manufacture them in China, and sell them anywhere in the world. This has led to major changes in the labor markets, especially to an increase in outsourcing, which has resulted in generally lower consumer prices; but it has caused job losses for some U.S. workers and gains for others. There have also been dramatic rises and falls in the stock market, and interest rates have remained low even as energy prices continue to rise. Corporate scandals have led to important changes in the laws governing corporate management and ﬁnancial reporting, as well as to equally important changes in managerial compensation. These issues are discussed in this edition of Fundamentals, where we analyze them from ﬁnancial and ethical perspectives. Our target audience is undergraduate students taking their ﬁrst, and often only, ﬁnance course. Some students will decide to major in ﬁnance and go on to take courses in investments, money and capital markets, and advanced corporate ﬁnance. Others will choose marketing, management, or some other nonﬁnance major. Still others will major in areas other than business and take ﬁnance and a few other business courses to gain information that will help them in law, real estate, and other ﬁelds. Our challenge was to provide a book that serves all of these audiences well. Our conclusion was that we should focus on the core principles of ﬁnance (i.e., on basic topics such as the time value of money, risk analysis, and valuation). Moreover, we concluded that we should address these topics from two points of view: (1) as an investor who is seeking to make intelligent investment choices and (2) as a business manager trying to maximize the value of his or her ﬁrm's stock. Note that both investors and managers need to know the same set of principles, so the core topics are important to students regardless of what they choose to do after they ﬁnish the course.
THE FINANCIAL CRISIS OF 2008 As everyone knows, the ﬁnancial markets experienced a meltdown in the fall of 2008. The average stock's price declined by about 50%, which wiped out trillions of dollars of savings. The (sick) joke was that 401 (k) retirement plans were becoming 201 (k) plans. These market losses delayed many retirements and also caused many retirees to go back to work. Housing construction virtually ceased, and home prices plunged by about 20% nationwide and by as much as 50% in some parts of the country, wiping out trillions more of savings. Millions of homeowners found that their mortgages exceeded the value of their homes, and defaults and foreclosures followed. This led to huge losses by banks and other lenders, which in turn led to bankruptcies, restructuring, and massive layoffs. Three years ago, there were many strong, old, and independent global investment banks. Today, all of those in the U.S. are gone—icons like Merrill Lynch and iii
Morgan Stanley have either gone bankrupt, sold out at rock bottom prices, or been forced to convert into regulated banks that are partially owned by the federal government. The credit markets literally froze up. Banks needed to conserve their cash to meet withdrawals; hence they refused to make loans even to strong industrial and retail companies, or home and auto purchasers. This quickly led to a severe slowdown in non-ﬁnancial businesses, accompanied by still more bankruptcies and layoffs. This happened all over the world, and the specter of a 1930s type depression was on the minds of central bankers and treasury ofﬁcials worldwide. As a result, coordinated government rescue plans were put into operation in most developed nations. We don't know at this point what will happen next. The best bet is that a depression will be avoided but a bad recession will occur. Going forward, companies and individuals will recognize that an excessive use of debt was the root cause of the ﬁnancial meltdown, hence there will be a smaller and more responsible use of debt in the future—at least until memories of 2008 fade. How should the 2008 Crisis affect the contents of this textbook? Here is our conclusion: l
The fundamental concepts of ﬁnance are unchanged; hence all the concepts covered in the book are still applicable. The problems of 2008 resulted largely because businesses, individuals, and government ofﬁcials did not pay sufﬁcient attention to the basic principles of ﬁnance as covered in the book. Therefore, there is no reason to change most of the book. We should, however, use the 2008 experience to illustrate the basic points made in the book. For example, we talk about risk, and 2008 can and should be used to drive home how risk can be measured and dealt with.
The economic situation is ﬂuid and dynamic. We may have a rapid recovery, which would be great, but, we might have a long, deep, and painful recession. We plan to use the Internet in the years ahead, while the book is in use, to update the situation on a chapter-by-chapter basis. As events related to the different chapters occur, we will provide updated vignettes and other information on the book' web site. We anticipate many important developments, hence a lot of updates. Still, the good news is that the basic, fundamental contents of the book will remain the same.
ORGANIZATION OF THE CHAPTERS: A VALUATION FOCUS As we discuss in Chapter 1, in an enterprise system such as that of the United States, the primary goal of ﬁnancial management is to help managers maximize their ﬁrms' values, subject to constraints such as not polluting the environment, not engaging in unfair labor practices, and not engaging in antitrust activities. Therefore, valuation underlies everything in Fundamentals. In Chapter 1, we discuss the concept of valuation, explain how it depends on future cash ﬂows and risk, and show why value maximization is good for society in general. The valuation theme runs throughout the text. Values are not established in a vacuum—stock and bond values are determined in the ﬁnancial markets, so an understanding of those markets is essential to anyone involved with ﬁnance. Therefore, Chapter 2 covers the major types of ﬁnancial markets, the returns that investors have historically earned, and the risks inherent in different types of securities. This information is important for anyone working in ﬁnance. It is also important for anyone who has or hopes to own ﬁnancial assets.
Asset values depend in a fundamental way on earnings and cash ﬂows as reported in the accounting statements. Therefore, we review those statements in Chapter 3. Then in Chapter 4, we show how accounting data can be analyzed and used to measure how well a com...