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 Table of Contents vii

4.8 Interpreting Financial Ratios 114 6.6 Corporate Bonds and the Risk of Default 198
Variations in Corporate Bonds 200
4.9 The Role of Financial Ratios—And a Final
Note on Transparency 117 6.7 International Bond Market Variations—Sukuk 203
Besides Financial Ratios . . . 119
6.8 Summary 206
Transparency 119
Appendix 6A: A More Detailed Look at the Yield
4.10 Summary 120
Curve 212

PART 2 CHAPTER 7
VALUE 128 Valuing Stocks 215
7.1 Stocks and Stock Markets 216
CHAPTER 5
Reading Stock Market Listings 218
The Time Value of Money 128
7.2 Market Values, Book Values, and Liquidation
5.1 Future Values and Compound Interest 129
Values 221
5.2 Present Values 133
7.3 Valuing Common Stocks 224
Finding the Interest Rate 137
Valuation by Comparables 224
Finding the Investment Period 138
Price and Intrinsic Value 225
5.3 Multiple Cash Flows 140 The Dividend Discount Model 227
Future Value of Multiple Cash Flows 140
7.4 Simplifying the Dividend Discount Model 230
Present Value of Multiple Cash Flows 142
The Dividend Discount Model with No
5.4 Level Cash Flows: Perpetuities and Annuities 144 Growth 230
How to Value Perpetuities 144 The Constant-Growth Dividend Discount
How to Value Annuities 146 Model 231
Annuities Due 150 Estimating Expected Rates of Return 232
Future Value of an Annuity 152 Non-constant Growth 233
Cash Flows Growing at a Constant Rate—Variations
7.5 Growth Stocks and Income Stocks 235
on Perpetuities and Annuities 155
7.6 There Are No Free Lunches on Bay Street 238
5.5 Inflation and the Time Value of Money 157
Method 1: Technical Analysis 239
Real Versus Nominal Cash Flows 157
Method 2: Fundamental Analysis 242
Inflation and Interest Rates 159
A Theory to Fit the Facts 243
Valuing Real Cash Payments 161
Real or Nominal? 162 7.7 Market Anomalies and Behavioural Finance 244
5.6 Effective Annual Interest Rates 162 Market Anomalies 244
Behavioural Finance 245
5.7 Summary 165
7.8 Summary 246
CHAPTER 6
Valuing Bonds 178 CHAPTER 8
Net Present Value and Other
6.1 Bonds and the Bond Market 180
Investment Criteria 256
Bond Market Data 180
8.1 Net Present Value 258
6.2 Interest Rates and Bond Prices 182
A Comment on Risk and Present Value 259
How Bond Prices Vary with Interest Rates 184
Valuing Long-Lived Projects 259
6.3 Current Yield and Yield to Maturity 186 Using the NPV Rule to Choose Among Projects 263
6.4 Bond Rates of Return 187 8.2 Other Investment Criteria 264
Taxes and Rates of Return 191 Payback 264
Multiperiod Rates of Return 192 Discounted Payback 266
Internal Rate of Return 267
6.5 The Yield Curve 193
A Closer Look at the Rate of Return Rule 268
Nominal and Real Rates of Interest 194
Calculating the Rate of Return for Long-Lived
The Determinants of the Yield Curve 196 Projects 269
Expectations Theory 196 A Word of Caution 271
Interest Rate Risk and the Liquidity Premium 197 Some Pitfalls of the IRR Rule 271
viii Table of Contents

8.3 More Examples of Mutually Exclusive Projects 275 10.2 Some “What If” Questions 329
The Investment Timing Problem 276 Sensitivity Analysis 330
The Choice Between Long- and Short-Lived Scenario Analysis 332
Equipment 277
10.3 Break-Even Analysis 333
Replacing an Old Machine 278
Accounting Break-Even Analysis 333
8.4 Capital Rationing 280 NPV Break-Even Analysis 335
Soft Rationing 280 Operating Leverage 338
Hard Rationing 280
10.4 Real Options and the Value of Flexibility 340
Pitfalls of the Profitability Index 281
The Option to Expand 340
8.5 A Last Look 282 A Second Real Option: The Option to Abandon 342
A Third Real Option: The Timing Option 343
8.6 Summary 283
A Fourth Real Option: Flexible Production
CHAPTER 9 Facilities 344
Using Discounted Cash Flow Analysis to Make 10.5 Summary 344
Investment Decisions 292
9.1 Identifying Cash Flows 293
PART 3
Discount Cash Flows, Not Profits 293
Discount Incremental Cash Flows 295 RISK 352
Include All Indirect Effects 296
Forget Sunk Costs 296 CHAPTER 11
Include Opportunity Costs 296 Introduction to Risk, Return, and the
Recognize the Investment in Working Capital 297 Opportunity Cost of Capital 352
Remember Shutdown Cash Flows 298
11.1 Rates of Return: A Review 353
Beware of Allocated Overhead Costs 298
Discount Nominal Cash Flows by the Nominal 11.2 Ninety Years of Capital Market History 355
Cost of Capital 298 Market Indexes 355
Separate Investment and Financing Decisions 300 The Historical Record 356
Using Historical Evidence to Estimate Today’s
9.2 Calculating Cash Flows 300
Cost of Capital 359
Capital Investment 300
Investment in Working Capital 300 11.3 Measuring Risk 360
Operating Cash Flow 301 Variance and Standard Deviation 362
A Note on Calculating Variance 363
9.3 Business Taxes in Canada and the Capital
Measuring the Variation in Stock Returns 364
Budgeting Decision 304
Depreciation and Capital Cost Allowance 304 11.4 Risk and Diversification 366
The Asset Class System 304 Diversification 366
Sale of Assets 306 Asset Versus Portfolio Risk 367
Termination of Asset Pool 307 Covariance and Correlation 369
Present Values of CCA Tax Shields 308 Correlation and Portfolio Diversification 370
Market Risk Versus Unique Risk 375
9.4 Example: Blooper Industries 310
Calculating Blooper’s Project Cash Flows 311 11.5 Thinking About Risk 377
Calculating the NPV of Blooper’s Project 313 Message 1: Some Risks Look Big and Dangerous
Further Notes and Wrinkles Arising from but Really Are Diversifiable 377
Blooper’s Project 314 Message 2: Market Risks Are Macro Risks 378
Message 3: Risk Can Be Measured 379
9.5 Summary 317
11.6 Summary 379
CHAPTER 10
Project Analysis 325 CHAPTER 12
10.1 How Firms Organize the Investment Process 326
Risk, Return, and Capital Budgeting 385
Stage 1: The Capital Budget 326 12.1 Measuring Market Risk 386
Stage 2: Project Authorizations 327 Measuring Beta 387
Problems and Some Solutions 327 Betas for Cameco and Royal Bank 390
 Table of Contents ix

Total Risk and Market Risk 390 PART 4

Portfolio Betas 392
FINANCING 444
12.2 Risk and Return and Capital Asset Pricing Model,
CAPM 393 CHAPTER 14
Why the CAPM Makes Sense 396 Introduction to Corporate Financing
The Security Market Line 397
and Governance 444
How Well Does the CAPM Work? 398
Using the CAPM to Estimate Expected Returns 401 14.1 Creating Value with Financing Decisions 446
12.3 Capital Budgeting and Project Risk 401 14.2 Common Stock 446
Company Risk Versus Project Risk 402 Book Value Versus Market Value 448
Determinants of Project Risk 403 Dividends 448
Don’t Add Fudge Factors to Discount Rates 404 Ownership of the Corporation 448
Voting Procedures 449
12.4 Summary 405
Classes of Stock 450
CHAPTER 13 Corporate Governance in Canada and
The Weighted-Average Cost of Capital Elsewhere 451
and Company Valuation 413 14.3 Preferred Stock 454
13.1 Geothermal’s Cost of Capital 414 14.4 Corporate Debt 456
Debt Comes in Many Forms 457
13.2 The Weighted-Average Cost of Capital 416
Innovation in the Debt Market 461
Calculating Company Cost of Capital as a
Weighted Average 416 14.5 Convertible Securities 464
Use Market Weights, Not Book Weights 419 14.6 Patterns of Corporate Financing 464
Taxes and the Weighted-Average Cost of Capital 419 Do Firms Rely Too Heavily on Internal Funds? 465
What If There Are Three (or More) Sources of External Sources of Capital 466
Financing? 421
Wrapping Up Geothermal 421 14.7 Summary 468
Checking Our Logic 421 Appendix 14A: The Bond Refunding Decision 472
13.3 Measuring Capital Structure 422
CHAPTER 15
13.4 Calculating Required Rates of Return 424 Venture Capital, IPOs, and Seasoned
The Expected Return on Bonds 424 Offerings 479
The Expected Return on Common Stock 425
The Expected Return on Preferred Stock 426 15.1 Venture Capital 481
Venture Capital Companies 482
13.5 Calculating the Weighted-Average
Cost of Capital 427 15.2 The Initial Public Offering 483
Real Company WACC 427 Arranging a Public Issue 484
13.6 Interpreting the Weighted-Average Cost of 15.3 The Underwriters 489
Capital 428 Who Are the Underwriters? 489
When You Can and Can’t Use WACC 428 15.4 Listing on the Stock Market 492
Some Common Mistakes 428
How Changing Capital Structure Affects WACC 15.5 Rights Issues and General Cash Offers
When the Corporate Tax Rate Is Zero 429 by Public Companies 492
How Changing Capital Structure Affects Debt Rights Issues 493
and Equity When the Corporate Tax Rate Is General Cash Offers 494
Zero 430 Costs of the General Cash Offer 495
What Happens If Capital Structure Changes Market Reaction to Stock Issues 496
and the Corporate Tax Rate Is Not Zero? 431 15.6 The Private Placement 496
Revisiting the Project Cost of Capital 432
15.7 Summary 497
13.7 Valuing Entire Businesses 433
Calculating the Value of the Concatenator Appendix 15A: The Financing of New and Small
Business 434 Enterprises 503
13.8 Summary 436 Appendix 15B: Hotch Pot’s New Issue Prospectus 510
x Table of Contents

PART 5 17.4 When Do Financial Leases Pay? 564

DEBT AND PAYOUT POLICY 514 17.5 Summary 565

CHAPTER 16 CHAPTER 18
Debt Policy 514 Payout Policy 571
16.1 How Borrowing Affects Value in a Tax-Free 18.1 How Dividends Are Paid 572
Economy 515 Cash Dividends 572
MM’s Argument 516 Some Legal Limitations on Dividends 573
How Borrowing Affects Earnings per Share 517 Stock Dividends, Stock Splits, and Reverse
How Borrowing Affects Risk and Return 519 Splits 574
Debt and the Cost of Equity 521 Dividend Reinvestment Plans and Share
Purchase Plans 575
16.2 Capital Structure and Corporate Taxes 523
Debt and Taxes at River Cruises 523 18.2 Share Repurchase 575
How Interest Tax Shields Contribute to the Value of Why Repurchases Are Like Dividends 576
Shareholders’ Equity 525 Repurchases and Share Valuation 577
Corporate Taxes and the Weighted-Average Cost of 18.3 How Do Companies Decide on How Much to Pay
Capital 526 Out? 577
The Implications of Corporate Taxes for Capital The Role of Share Repurchase Decisions 578
Structure 527 The Information Content of Dividends and
16.3 Costs of Financial Distress 527 Repurchases 579
Bankruptcy Costs 528 18.4 Why Payout Policy Should Not Matter 581
Evidence on Bankruptcy Costs 529 Payout Policy Is Irrelevant in Efficient Financial
Direct Versus Indirect Costs of Bankruptcy 530 Markets 581
Financial Distress Without Bankruptcy 530 The Assumptions Behind Dividend-
Costs of Distress Vary with Type of Asset 532 Irrelevance 582
16.4 Explaining Financing Choices 533 18.5 Why Dividends May Increase Firm Value 584
The Trade-Off Theory 533 Market Imperfections 584
A Pecking-Order Theory 534
18.6 Why Dividends May Reduce Firm Value 585
The Two Faces of Financial Slack 535
Why Pay Any Dividends at All? 586
16.5 Bankruptcy Procedures 537 Dividends Versus Capital Gains 586
The Choice Between Liquidation and Dividend Clientele Effects 587
Reorganization 540
18.7 Summary 587
16.6 Summary 541
PART 6
CHAPTER 17
Leasing 549 FINANCIAL PLANNING 595
17.1 What Is a Lease? 550
CHAPTER 19
Leasing Industry 551
Long-Term Financial Planning 595
17.2 Why Lease? 552
19.1 What Is Financial Planning? 596
Sensible Reasons for Leasing 552
Financial Planning Focuses on the Big Picture 596
Some Dubious Reasons for Leasing 553
Why Build Financial Plans? 597
17.3 Valuing Leases 555
19.2 Financial Planning Models 598
Operating Leases 555
Components of a Financial Planning Model 598
Financial Leases 556
Percentage-of-Sales Models 599
Cash Flows of a Financial Lease 557
An Improved Financial Planning Model 601
Who Really Owns the Leased Asset? 558
Leasing and the Canada Revenue Agency (CRA) 559 19.3 Tips for Planners 607
First Pass at Valuing a Financial Lease Contract 559 Pitfalls in Model Design 607
Financial Lease Evaluation 562 The Assumption in Percentage-of-Sales
Using Formulas to Evaluate Financial Leases 562 Models 607
 Table of Contents xi

Forecasting Interest Expense 609 21.3 Managing Inventories of Cash 670

The Role of Financial Planning Models 610 Uncertain Cash Flows 671
19.4 External Financing and Growth 610 Cash Management in Practice—Now and Then 673

19.5 Summary 614 21.4 Investing Idle Cash: The Money Market 674
Yields on Money Market Investments 677
CHAPTER 20 21.5 The International Money Market 677
Short-Term Financial Planning 622
21.6 Summary 678
20.1 Links Between Long-Term and Short-Term
Financing 624 CHAPTER 22
20.2 Working Capital 626 Credit Management and Collection 682
The Components of Working Capital 627 22.1 Terms of Sale 683
Net Working Capital, Operating Cycle, and the Cash
Conversion Cycle 629 22.2 Credit Agreements 686
The Working Capital Trade-Off 632 22.3 Credit Analysis 686
20.3 Tracing Changes in Cash and Working Capital 633 Financial Ratio Analysis 687
Numerical Credit Scoring 687
20.4 Cash Budgeting 635 When to Stop Looking for Clues 690
Forecast Sources of Cash 635
Forecast Uses of Cash 637 22.4 The Credit Decision and Revisiting the Terms
The Cash Balance 637 of Sale 691
Credit Decisions with Repeat Orders 692
20.5 A Short-Term Financing Plan 640 Evaluating a Credit Policy Switch 694
Dynamic Mattress’s Financing Plan 640
Some General Principles for the Credit
Evaluating the Plan 641
Decision and Credit Terms 694
20.6 Sources of Short-Term Financing 642 22.5 Collection Policy 696
Bank Loans 642
Secured Loans 642 22.6 Summary 697
Factoring 644
Commercial Paper 645 PART 8
Banker’s Acceptance 646
SPECIAL TOPICS 704
20.7 The Cost of Bank Loans 646
Simple Interest 646
CHAPTER 23
Discount Interest 646
Mergers, Acquisitions, and Corporate
Interest with Compensating Balances 647
Control 704
20.8 Summary 648
23.1 Sensible Motives for Mergers 706
Increased Revenues 708
PART 7 Economies of Scale 709
SHORT-TERM FINANCIAL Economies of Vertical Integration 709
DECISIONS 657 Combining Complementary Resources 709
Merging to Reduce Taxes 710
Mergers as a Use for Surplus Funds 710
CHAPTER 21
Cash and Inventory Management 657 23.2 Dubious Reasons for Mergers 710
Diversification 710
21.1 Managing Cash Balances 658
The Bootstrap Game 711
Cheque Handling and Float 659
Other Payment Systems 662 23.3 The Mechanics of a Merger 712
Electronic Funds Transfer 663 The Form of Acquisition 712
International Cash Management 664 Mergers, Antitrust Law, and Popular
Opposition 714
21.2 Managing Inventories 665
Inventory Management Models 665 23.4 Evaluating Mergers 715
Just-in-Time Inventory Management 668 Mergers Financed by Cash 715
Radio Frequency Identification (RFID) 668 Mergers Financed by Stock 717
xii Table of Contents

Some Tax Issues 718 CHAPTER 25

A Warning 718 Options 763
Another Warning 718
25.1 Calls and Puts 765
23.5 The Market for Corporate Control 719 Selling Calls and Puts 767
Ownership Structure and the Effectiveness of the Payoff Diagrams Are Not Profit Diagrams 768
Market for Corporate Control 719 Financial Alchemy with Options 769
23.6 Method 1: Proxy Contests 720 Some More Option Magic 770

23.7 Method 2: Takeover Bids 721 25.2 What Determines Option Values? 771
Takeover Bid Tactics 721 Upper and Lower Limits on Option Values 771
The Determinants of Option Value 772
23.8 Method 3: Leveraged Buyouts 723 Option-Valuation Models 773
Barbarians at the Gate? 724
Recent LBO Activity 726 25.3 Spotting the Option 776
Options on Real Assets 776
23.9 Method 4: Divestitures, Spin-Offs, and Equity Options on Financial Assets 777
Carve-Outs 727
25.4 Summary 781
23.10 The Benefits and Costs of Mergers 729
23.11 Summary 731
CHAPTER 26
CHAPTER 24 Risk Management 787
International Financial Management 736 26.1 Why Hedge? 788
24.1 Foreign Exchange Markets 737 The Evidence on Risk Management 790
Spot Exchange Rates 737 26.2 Reducing Risk with Options 790
Forward Exchange Rates 740
26.3 Futures Contracts 791
24.2 Some Basic Relationships 741 The Mechanics of Futures Trading 794
Exchange Rates and Inflation 742 Commodity and Financial Futures 795
Inflation and Interest Rates 743
Interest Rates and Exchange Rates 745 26.4 Forward Contracts 796
The Forward Rate and the Expected Spot Rate 746 26.5 Swaps 797
Some Implications 747
26.6 Innovation in the Derivatives Market 800
24.3 Hedging Exchange Rate Risk 748
26.7 Is “Derivative” a Four-Letter Word? 800
Transaction Risk 748
Economic Risk 748 26.8 Summary 801
24.4 International Capital Budgeting 749 Appendix A: Present Value Tables A-1
Net Present Value Analysis 749
Glossary GL-1
The Cost of Capital for Foreign Investment 751
Political Risk 751 Index IN-1
Avoiding Fudge Factors 754
24.5 Summary 756
 PREFACE

This book is about corporate finance. It focuses on how com- and numerical examples. The ideas provide the “why”
panies invest in real assets and how they raise the money to behind the tools that good financial managers use to make
pay for these investments. It also provides a broad introduc- investment and financing decisions.
tion to the financial landscape, discussing, for example, the
major players in financial markets, the role of financial insti- WHY USE OUR BOOK
tutions in the economy, and how securities are traded and We wrote this book to make financial management clear,
valued by investors. It offers a framework for systematically useful, interesting, and fun for the beginning student. We
thinking about most of the important financial problems set out to show that modern finance and good financial
that both firms and individuals are likely to confront. practice go together—even for the financial novice. The key
Financial management is important, interesting, and to this is a thorough understanding of the principles and
challenging. It is important because today’s capital invest- mechanics of the time value of money. This material under-
ment decisions may determine the businesses that the firm lies almost all of this text, and we spend a lengthy Chapter 5
is in 10, 20, or more years ahead. Also, a firm’s success or providing extensive practice with this key concept.
failure depends in large part on its ability to find the capital The second component of our approach is the extensive
that it needs. use of numerical examples. Each chapter presents detailed
Finance is interesting for several reasons. Financial deci- numerical examples to help the reader become familiar and
sions often involve huge sums of money. Large investment comfortable with the material. We have peppered the book
projects or acquisitions may involve billions of dollars. Also, with real-life illustrations of the chapters’ topics. Some of
the financial community is international and fast-moving, these are excerpts from the financial press found in Finance
with colourful heroes and a sprinkling of unpleasant villains. in Action boxes; others are built into the text as examples.
Finance is challenging. Financial decisions are rarely cut By connecting concepts with practice, we strive to give
and dried, and the financial markets in which companies students a working ability to make financial decisions.
operate are changing rapidly. Good managers can cope with We have streamlined the treatment of most topics to
routine problems, but only the best managers can respond avoid getting bogged down in unnecessary detail that can
to change. To handle new problems, you need more than overwhelm a beginner. We don’t assume users will have a
rules of thumb; you need to understand why companies lot of background knowledge.
and financial markets behave as they do and when common We have written the book in a relaxed and informal
practice may not be best practice. Once you have a con- writing style. We use mathematical notation only where
sistent framework for making financial decisions, complex necessary. Even when we present an equation, we usu-
problems become more manageable. ally write it in words before using symbols. This approach
This book provides that framework. It is not an ency- has two advantages: it is less intimidating and it focuses
clopedia of finance. It focuses instead on setting out the attention on the underlying concept rather than just the
basic principles of financial management and applying them formula.
to the main decisions faced by the financial manager. It
explains why the firm’s owners would like the manager
to increase firm value and shows how managers choose WAYS TO USE OUR BOOK
between investments that may pay off at different points of Because there are about as many effective ways to orga-
time or have different degrees of risk. It also describes the nize a course in corporate finance as there are teachers,
main features of financial markets and discusses why com- we have ensured that many topics can be introduced in
panies may prefer a particular source of finance. different orders. For example, (1) we have made sure that
We organize the book around the key concepts of mod- Part Six (Financial Planning) can easily follow Part One
ern finance. These concepts, properly explained, make the (Introduction); (2) although we discuss working capital
subject simpler, not more difficult. They are also more after the basic principles of valuation and financing, we
practical. The tools of financial management are easier have made it possible for instructors to reverse that order
to grasp and use effectively when presented in a consis- (as many prefer to do); and (3) although the opportunity
tent conceptual framework. Modern finance provides that cost of capital depends on project risk, the chapters on
framework. project valuation and those on risk and return are written
Modern financial management is not “rocket science.” It in such a way that the two groups can be presented in
is a set of ideas that can be made clear by words, graphs, any order.
xiv Preface

CHANGES IN THE SIXTH CANADIAN EDITION Chapter 7 (Valuing Stocks). Updated marked-based
This sixth Canadian edition of Fundamentals includes many data. New material on the value of future investment. New
updates. We have enhanced the analytical tools used with Finance in Action box, “Facebook IPOs.”
the book: more spreadsheet boxes are integrated into the Chapter 8 (Net Present Value and Other Investment
chapters; end-of-chapter problems include exercises that Criteria) has been streamlined and reorganized. The chapter
ask students to use a variety of Internet resources to solve includes new discussion on calculating NPV using an exam-
financial problems and integrative mini cases. The location ple for the Cape Wind Project including spreadsheet appli-
of some chapters in the book has been altered to improve cations and problems. The chapter also has an enhanced
the logical flow of topics. In addition, we have rewritten, explanation of why mutually exclusive investments are
rearranged, and added material to improve readability and central to almost all real-life investment decisions and how
update coverage across chapters. The following are some that affects the capital budgeting decision.
examples of the changes that we have made. Chapter 9 (Using Discounted Cash Flow Analysis to
Chapter 1 (Goals and Governance of the Firm) has Make Investment Decisions) has been updated to include
been largely rewritten to improve readability and inter- new information on capital cost allowance (CCA). The
est. This chapter includes the real-life case of Tim Hortons chapter works through a realistic comprehensive example
and its founders Ron Joyce and Tim Horton, illustrating of capital budgeting analysis. An appendix showing how
how financial markets help infant enterprises grow into the CCA tax shield is derived is available to the reader on
healthy adults. The section on business organizations has Connect.
new material on private corporations and the pros and cons Chapter 10 (Project Analysis). The updated chapter
of being a public corporation. Examples of investment and includes revised coverage of real options and explains how
financial decisions of well-known companies are used to those options are integrated into a firm’s longer-term stra-
illustrate the main activities of financial managers, the role tegic considerations. Updated Finance in Action material
of financial markets, and the goals of a corporation. Keep- includes an article on FedEx’s use of options.
ing in mind the currency of certain themes, the chapter Chapter 11 (Introduction to Risk, Return, and the
includes expanded discussion of agency issues, including Opportunity Cost of Capital) starts with an updated his-
additions on corporate raiders, creative accounting and tax torical survey of returns on bonds and stocks and goes on
avoidance. There is also new content on the ethical issues to distinguish between the unique risk and market risk of
that confront managers and new discussion on the global individual stocks using updated market-based data from
financial crisis. Yahoo Finance.
Chapter 2 (Financial Markets and Institutions) opens Chapter 12 (Risk, Return, and Capital Budgeting) shows
with the history of Apple Computer. The chapter has addi- how to measure market risk and discusses the relationship
tional coverage on prediction markets and also includes between risk and expected return, now uses updated mar-
additional discussion of the financial crisis and its spillover ket data from Yahoo Finance.
to the sovereign debt crisis in the eurozone. Chapter 13 (The Weighted-Average Cost of Capital and
Chapter 3 (Accounting and Finance) includes an Company Valuation). Market data has been updated. There
updated discussion of new Canadian accounting standards is a discussion of the choice of the risk-free security, Trea-
for public companies, which are the International Financial sury bill, or long-term government bond when implement-
Reporting Standards (IFRS). IFRS financial statements of a ing CAPM.
Canadian company have been included. The discussion of Chapter 14 (Introduction to Corporate Financing and
profits versus cash flow includes examples of how accrual Governance) has been extensively updated, and features an
accounting impacts cash flow. The tax rates have also been extended treatment of corporate governance. A new Finance
updated. in Action box discusses the role of corporate governance
Chapter 4 (Measuring Corporate Performance). This in the context of enhancing shareholder value. The chap-
chapter explains various formulas for measuring corporate ter includes new discussion pertaining to innovations in the
performance and provides clear definitions of various con- bond market, and a new Finance in Action box discusses
cepts. NOPAT, ROA, and ROE are discussed. IFRS finan- new regulatory proposals for Canadian commercial paper.
cial statements of another Canadian company in the same Chapter 15 (Venture Capital, IPOs, and Seasoned Offer-
industry have been included for comparison. ings). The chapter introduces alternative fundraising meth-
Chapter 5 (The Time Value of Money) has been ods for startups such as crowdsourcing. The chapter also
updated and rearranged to improve logical flow. The chap- has updated material on the IPO market and on underwrit-
ter includes new spreadsheet applications. ers. An appendix to the chapter discussing the financing
Chapter 6 (Valuing Bonds). Updated market-based bond of new and small enterprises has been rewritten to reflect
data and institutional information. New material on interna- changes in the venture capital industry and other sources
tional bond market variations. of small business financing in Canada.
 Preface xv

Chapter 16 (Debt Policy) has been updated with Cana- Chapter 22 (Credit Management and Collection). New
dian examples and statistics in the discussions on costs of material on numerical credit scoring. The general principles
financial distress and explaining financing choices. for the credit decision updated with a discussion of the five
Chapter 17 (Leasing) now has updated information on Cs that determine credit terms.
the leasing industry. Chapter 23 (Mergers, Acquisitions, and Corporate Con-
Chapter 18 (Payout Policy) has been updated with a trol). Updated to include three recent large merger deals
revamped treatment of the trade-offs governing the use of in Canada. Added an example of a private firm in mergers
dividends versus share repurchases and includes additional and acquisitions, The Bagg Group. Added Montreal-based
discussion on the role of share repurchase decisions. Two Osisko Mining Corp. example. Added a proposal of new
new Finance in Action boxes have been added: one describ- rules on hostile takeover bids in Canada. Added examples
ing the special dividend of Bakery Canada Bread Co. and of leveraged buyouts, Gates Global and Informatica. Added
the other discussing the effect on share prices of significant new analysis of global mergers and acquisitions market from
dividend cuts by J.P. Morgan. Boston Consulting Group. Added that the performance of
Chapter 19 (Long-Term Financial Planning). The finan- the Guggenheim Spin-Off exchange-traded fund has outper-
cial planning model has been updated. A crucial aspect of formed the S&P 500. More details about the success of the
long-term planning is the use of Excel spreadsheets which equity carve-out of Tim Hortons.
is an important part of this chapter. Chapter 24 (International Financial Management) has
Chapter 20 (Short-Term Financial Planning) has been extensive updates and new discussion on the global financial
significantly updated with new examples of short-term crisis, including two Finance in Action articles on the effects
financing. A discussion of bank lending practices and the of the crisis on Greece and Italy. Another new Finance in
importance of bank loans for small and mid-sized operations Action box discusses the outlook for the Canadian dollar.
is included. Chapter 25 (Options). Market option prices updated.
Chapter 21 (Cash and Inventory Management). The New Finance in Action box, “The Fear Index,” and new
section on managing cash balances has been updated. New Excel spreadsheet.
section on radio frequency identification (RFID). More Chapter 26 (Risk Management) includes a new Finance
information on yields on money market investments and in Action box that illustrates the risks of excessive specula-
the international money market. tion and how fortunes can be lost.
Visit https://testbankfan.com
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xvi Preface FINANCE IN ACTION
Fourth Pass Fourth Pass

WALK-THROUGH
To provide guidance and insights
throughout the text, we include a
CHAPTER
15 Founder of Microcredit Movemen in 2004 at a price of $85 a share, putting a value on the
enterprise of $23 billion.
Mike Lazardis quit his studies in electrical engineering
at the University of Waterloo at 23.1 In 1984 he started
Research In Motion (RIM) with two friends. RIM went
public in 1997, offering 13.8 million common shares at $7.25

number of proven pedagogical aids: each on the Toronto Stock Exchange. RIM’s product, the
BlackBerry e-mail pager-cum-computer, was such a success
that by early 2000 its shares were trading at $260. Mike

VENTURE CAPITAL, IPOS, Lazardis became a billionaire and recently shared an

Bangladesh’s Muhammad Yunus and the bank he founded, Gr Academy Award for technical achievement with a co-

AND SEASONED OFFERINGS worker for designing a device that quickened the pace of
film editing. The name of the company was recently
Bank, which created a new category of banking by granting m
Tobi Lütke, Founder & Chief Executive Officer, Shopify Inc., joined by
members of Shopify’s leadership team and Lou Eccleston, Chief Executive
Officer, TMX Group, opens the market at Toronto Stock Exchange on May
changed from RIM to BlackBerry.
Such stories illustrate that the most important asset of

of small loans to poor people with no collateral—helping to es

26, 2015, to celebrate the company’s initial public offering (IPO). a new firm may be a good idea. But that is not all you need.
To take an idea from the drawing board to a prototype and
Bill Gates and Paul Allen founded Microsoft in 1975 when through to large-scale production requires ever-greater
Learning Objectives
the microcredit movement across the developing world—won the
they were both around 20. Eleven years later, Micro- amounts of capital.
After studying this chapter, you should be able to: soft shares were sold to the public for $21 a share and To get a new company off the ground, entrepreneurs

CHAPTER OPENING
immediately zoomed to $35. The largest shareholder was may rely on their own savings and personal bank loans.
LO1 Explain how venture capital firms design successful deals.
LO2 Explain how firms make initial public offerings and the costs of such
offerings.
Nobel Peace Prize. The Norwegian Nobel Committee said on it
Bill Gates, whose shares in Microsoft then were worth
US$350 million.
But this is unlikely to be sufficient to build a successful
enterprise. Venture capital firms specialize in providing
In 1976 two college dropouts, Steve Jobs and Steve new equity capital to help firms over the awkward-adolescent

Each chapter begins with numbered

LO3

LO4
State what is involved when established firms make a general cash offer
or a private placement of securities.
Explain the role of the underwriter in an issue of securities.
site that it awarded the prize to Yunus and the Bank “for their eff
Wozniak, sold their most valuable possessions, a van and
a couple of calculators, and used the cash to start man-
period before they are large enough to “go public.” In
the first part of this chapter, we will explain how venture
ufacturing computers in a garage. In 1980 when Apple capital firms do this.
LO5 Discuss some of the significant questions that arise when established
create economic and social benefit from below.”
Computer went public, the shares were offered to inves- If the firm continues to be successful, there will likely

learning objectives (LOs) providing firms make a rights issue, a general cash offer, or a private placement of
securities.
tors at $22 and jumped to $36. At that point, the shares
owned by the company’s two founders were worth
come a time when it needs to tap a wider source of
capital. At this point it will make its first public issue of com-

The Grameen Bank lends small amounts of money to peop

US$414 million. mon stock. This is known as an initial public offering, or IPO.

a quick introduction to the mate- In 1996 two Stanford computer science students, Larry In the second section of the chapter we will describe what is

would normally be refused loans by mainstream banks. Back i

Page and Sergey Brin, decided to collaborate to develop involved in an IPO.
a Web search engine. To help turn their idea into a com- A company’s initial public offering is seldom its last.

rial students will learn and should mercial product, the friends succeeded in raising almost

Yunus was struck by the plight of 22-year-old Sophia Khatoon,

$1 million from several wealthy investors (known as angels),
and this was later supplemented by funding from two ven-
In Chapter 14 we saw that internally generated cash is
not usually sufficient to satisfy the firm’s needs. Estab-
lished companies make up the deficit by issuing more

understand fully before moving to ture capital firms that specialized in helping young startup

gling to survive in a small Bangladeshi village called Jobra. She w

businesses. The company, now named Google, went public
equity or debt. The remainder of this chapter looks at
this process.

the next chapter. This is followed by 7 days a week making finely woven bamboo furniture. Becau
a narrative to set the stage for what had no working capital, she was forced to buy her materials on
follows.
1 While it is true that some of these highly successful entrepreneurs dropped out of college or university, we do not want to give the impression that quitting

Yunus, then a professor of economics at a nearby university, calc

school had anything to do with their success.

480

bre24962_ch15_479-513.indd 479 12/08/15 03:37 PM

that she was paying 10% interest per day—more than 3,000% pe
bre24962_ch15_479-513.indd 480 12/08/15 03:37 PM

NUMBERED EXAMPLES
Numbered and titled examples are extensively integrated into the chapters to provide detailed its financing is not ver
applications and illustrations of the text material. to financing was vital.
operate in a country w
requires
Third Pass a well-function
FINANCE IN ACTION BOXES A modern financial
company’s age, its grow
Almost every chapter includes at least one Finance FINANCE IN ACTION venture capital financi
in Action box. The boxes present excerpts, usu-
Implications of IFRS for the Retail Industry markets. Still later, as t
ally from the financial press, providing real-life
the examples given in T
illustrations of the chapter’s topics.
As their lenders, suppliers, customers and competitors switch to inter- pertaining to lease accounting. This will include reviewing thechannels
account- open to mode
national financial reporting standards, even privately-owned retailers ing treatment of pre-opening costs, rent-free periods, step rent, other
will be affected. David Bromley, partner at PricewaterhouseCoopers, lease incentives, contingent rental payments, as well as asset book,
retire- and new channe
discusses some of the special considerations for retailers, such as ment obligations. Under IFRS, the classification of leases is determined
leases and loyalty programs. using guidelines that are more qualitative in nature and requirea morerecent innovation kn
Q Who does IFRS apply to in the retail sector? professional judgment. In addition, a new IFRS standard on leases is
expected to be issued in the coming years, which may require of the world.
all leases
A IFRS is relevant to all publicly listed retail companies. But a Canadian
to be capitalized on the balance sheet. This could have a significant
retailer that is private could also be interested in IFRS. For fiscal years
impact on the financial statements of retail companies.
beginning on or after Jan. 1, 2011, retailers in the private sector will have
to choose either to adopt IFRS or Canadian GAAP for Private Enter- Q I’ve heard IFRS referred to as standing for, “I feel really stressed.”
prises. IFRS may be the best alternative if you are considering going Do you have a sense of how well prepared retailers are for this?

THE FLOW O
public in the future, have an exit strategy that could involve acquisition A PricewaterhouseCoopers LLP conducted a survey with the Canadian
by an IFRS reporter or private-equity interest, or have banking institu-
tions that require IFRS-compliant financial statements. LO1, 2 2.2
Financial Executives Research Foundation during April 2009 to gauge
the progress of Canadian companies in their conversion to IFRS. Of
the 147 public companies that were surveyed, 80% indicated they
Q Are there any aspects of IFRS that impact retailers differently from other
businesses or issues unique to retail that affect the transition in any way? remained short of the halfway mark in their overall conversion process.

The money that corpor

A Retail companies normally have a significant number of leased loca-
tions across the country. That means retailers are going to have to
Source: Excerpted from Hollie Shaw, “Rebalancing the Financials: Retail,” Financial
Post, September 24, 2009, FP14. Material reprinted with the express permission of

INTERNATIONAL ICON But there can be ma

focus on identifying differences between Canadian GAAP and IFRS National Post, a division of Postmedia Network Inc.

A distinctive icon (shown here) appears where the authors discuss The road can pass thro
global issues.
Leasing Affects Book Income Leasing can make the firm’s balance sheet and income
statement look better by increasing book income or decreasing book asset value, or both.
Let’s start with the s
In Motion (RIM) in its
A lease that qualifies as off-balance-sheet financing affects book income in only one way:
the lease payments are an expense. If the firm buys the asset instead and borrows to finance

ETHICS ICON The red arrows in Figu

it, both depreciation and interest expense are deducted. Leases are usually set up so that
payments in the early years are less than depreciation plus interest under the buy-and-borrow

investment
alternative. Consequently, leasing increases book income in the early years of an asset’s life.
in this sim
A distinctive icon (shown here) appears where the authors discussThe book rate of return can increase even more dramatically, because the book value
assets (the denominator in the book-rate-of-return calculation) is understated if the leased
of

(arrow 1) or it can rei

ethical issues or the implications of unethical practices. asset never appears on the firm’s balance sheet.

Cash retained and

Leasing’s impact on book income should in itself have no effect on firm value. In efficient
means
capital markets, investors will look through the firm’s accounting results to the true value of additional saving
the asset and the liability incurred to finance it.
reinvested in the out to those sharehold
LO2, 3 17.3 VALUING LEASES firm’s operations taking and spending th
is cash saved
Typically, any analysis of leasing an asset involves examining the costs and benefits of this
option relative to the alternative: buying the asset. In this section, we discuss how operating
Of course, this sma
and invested on loan, for example. The
KEY POINTS
and financial leases are valued.

OPERATING LEASES
behalf of the firm’s In this case investors’ s
These marginal boxes, identified with the icon shown at Leases can be attractive for a variety of reasons. However, the decision to lease requires
Now consider a lar
right, summarize the adjoining material, at the same time shareholders.
careful calculation of the cash inflows and outflows from the lease. If you are considering
an operating lease, decide whether it is cheaper to lease the asset for the time that you need
it or to buy it. Figure out the equivalent annual cost of buying the asset and compare What’s
it to different? Scale, 6

helping students focus on the most critical content.

6 Look back at Chapter 8 for a review of equivalent annual cost and an example of the analysis of an operating lease.

36 555

bre24962_ch17_549-570.indd 555 12/08/15 03:40 PM

 of dividend payment depends partly on how investors will interpret the decision
year’s dividend was only $50, investors might regard a dividend payment of $100 as a
Financial models a confident management; if last year’s dividend was $150, investors might not be so c
ensure consistency with a payment of $100. The alternative of paying $180 in dividends and making
between growth shortfall by issuing more debt leaves the company with a debt-equity ratio of 77%.
assumptions and unlikely to make your bankers edgy but you may worry about how long you can co
Preface financing plans, but
they do not identify
to finance expansion predominantly by borrowing.
Our example shows how experiments with a financial model, including changes
xvii
the best financing plan. model’s balancing item, can raise important financial questions. But the model do
answer these questions.

CHECK POINT QUESTIONS

Check Point 19.1 Suppose that the firm decides to maintain its debt-equity ratio at 800/1,200 = 2/3. It is comm
Numbered Check Point boxes with questions are provided to increasing assets by 10% to support the forecast increase in sales, and it strongly believe
a dividend payment of $180 is in the best interests of the firm. What must be the balancing i
in each chapter to enable students to check their under- What is the implication for the firm’s financing activities in the next year?
standing as they read. Both conceptual and calculation-type
questions have been included in this edition. Answers are AN IMPROVED FINANCIAL PLANNING MODEL
provided at the end of each chapter. Now that you have grasped the idea behind financial planning models, we can move
more sophisticated example.
Table 19.4 shows 2014 financial statements for Yummy Food Company, a fictiona
pany (all numbers shown with thousands dropped to save space). Revenue was $2,00
KEY FORMULAS Its 2014 earnings before interest and taxes (EBIT), $200,000, were 10% of sales revenu
income was $96,000 after payment of taxes and 10% interest paid on $400,000 of lon
debt. The company paid out two-thirds of its net income as dividends.
Key mathematical formulas, identified by a number, are called out in the
net operating text.
working capital The first entry on the balance sheet is net operating working capital (NOWC
(NOWC) Operating current
A summary of these key formulas can be found by visiting Connect.
assets minus operating current ating current assets minus operating current liabilities. Operating current assets con
liabilities, excluding interest- current assets needed for the operation of the business, including trade receivables, p
bearing debt. expenses, inventory, and cash needed to operate the business. Non-operating current

KEY TERMS
Key terms, when introduced, appear in colour and bold in the main text and
are defined in the margin. A glossary made up of all these definitions is also
available at the back of the book and on Connect. bre24962_ch19_595-621.indd 601 12/22/15

Fourth Pass

CALCULATOR BOXES AND

EXERCISES FINANCIAL CALCULATOR
In a continued effort to help students grasp the An Introduction to Financial Calculators
critical concept of time value of money, many
pedagogical tools have been added throughout Financial calculators are designed with present value and future value Why does the minus sign appear? Most calculators treat cash flows
formulas already programmed. Therefore, you can readily solve many as either inflows (shown as positive numbers) or outflows (negative
the text. Financial Calculator boxes provide problems simply by entering the inputs for the problem and punching
a key for the solution.
numbers). For example, if you borrow $100 today at an interest rate of
12%, you receive money now (a positive cash flow), but you will have to
examples of solving a variety of problems with The basic financial calculator uses five keys that correspond to the
inputs for common problems involving the time value of money.
pay back $112 in a year, a negative cash flow at that time. Therefore, the
calculator displays FV as a negative number. The following time line of

directions for the three most popular financial n i PV FV PMT

cash flows shows the reasoning employed. The final negative cash flow
of $112 has the same present value as the $100 borrowed today.

calculators. Each key represents the following input:

PV  $100

• n is the number of periods. (We have been using t to denote the Year: 0 1
length of time, or number of periods. Most calculators use n for
the same concept.)
FV  $112
• i is the interest rate per period, expressed as a percentage (not
a decimal). For example, if the interest rate is 8%, you would If, instead of borrowing, you were to invest $100 today to reap a
enter 8, not .08. On some calculators this key is written I/Y future benefit, you would enter PV as a negative number (first press
or I/YR. (We have been using r to denote the interest rate or 100, then press the +/− key to make the value negative, and finally
discount rate.) press PV to enter the value into the PV register). In this case, FV would
• PV is the present value. appear as a positive number, indicating that you will reap a cash inflow
• FV is the future value. when your investment comes to fruition.
• PMT is the amount of any recurring payment (called an annuity).
In single cash-flow problems such as those we have considered so Present Values
far, PMT is zero. Suppose your savings goal is to accumulate $10,000 by the end of
Thirdto Pass
30 years. If the interest rate is 8%, how much would you need invest
Given any four of these inputs, the calculator will solve the fifth. We will
today to achieve your goal? Again, there is no recurring payment

EXCEL SPREADSHEETS AND

illustrate with several examples.
involved, so PMT is zero. We therefore enter the following: n = 30;
Future Values i = 8; FV = 10,000; PMT = 0. Now compute PV, and you should get
an answer of −993.77. The answer is displayed as a negative number

EXHIBITS
Recall Example 5.1, where we calculated the future value of Peter
Minuit’s $24 investment. Enter 24 into the PV register. (You enter because you need to make a cash outflow (an investment) of $993.77
EXCEL
the value SPREADSHEET
by typing 24 and then pushing the PV key.) We assumed an now in order to enjoy a cash inflow of $10,000 in 30 years.
interest rate of 8%, so enter 8 into the i register. Because the $24 had
Excel Spreadsheet boxes are integrated into 380 years to compound, enter 380 into the n register. Enter 0 into
Finding the Interest Rate
The 47-year IOU from Puerto Rico in Example 5.3 sold at $94.40 and

many chapters and provide the student with Internal Rate of Return
the PMT register because there is no recurring payment involved in
the calculation. Now ask the calculator to compute FV. On some calcu-
promised a final payment of $1,000. We may obtain the market inter-
est rate by entering n = 47, FV = 1,000, PV = −94.40, and PMT = 0.
lators you simply press the FV key. On others you need to first press
Compute i and you will find that the interest rate is 5.15%. This is the
detailed examples of how to use spreadsheets in the “compute” key (which may be labelled COMP or CPT), and then
press FV. The exact sequence of keystrokes for three popular financial
value we computed directly (but with more work) in the “Finding
the Interest Rate” section of this chapter.
applying financial concepts. They give students calculators is as follows:* A B C D E
How Long an Investment?
F

1 Calculating IRR byInUsing a Spreadsheet

a valuable introduction to financial modelling. Hewlett-Packard
HP-10B
Sharp
EL-738C
Texas Instruments
BA II Plus
Example 5.5, we consider how long it would take for an investment
to double in value. This sort of problem is easily solved using a cal-
2 culator. If the investment is to double, we enter FV = 2 and PV = −1.
We show how spreadsheets can be used in time- 24
380
PV
N
24
380
PV
n
24
380
PV
N
If the interest rate is 9%, enter i = 9 and PMT = 0. Compute n and you
will find that n = 8.04 Formula
years. If the interest rate is 9.05%, the doubling
83
value-of-money and security valuation problems, 8
0
I/YR
PMT 0
tYear
PMT
Cash Flow
8 I/Y
0 PMT
period falls to 8 years, as we found in the example.

in capital budgeting, and in long- and short-term FV COMP4 FV 0 2350,000

CPT FV IRR 5 *The BA
0.1296 5IRR(B4:B7)
II Plus calculator requires a little extra work to initialize. When you buy
the calculator, it is set to automatically interpret each period as a year and assumes
that interest compounds monthly. In our experience, it is best to change the com-
You should find after hitting
5 the1FV key that16,000
your calculator shows
planning applications. Questions that apply to a value of −120.5697 trillion, which, except for the minus sign, is the
pounding frequency to once per period. To do so, press 2nd {P/Y} 1 ENTER , then
press 1 ENTER and finally press 2nd {QUIT} to return to standard calculator
future value of the $24. mode. You should need to do this only once, even if the calculator is turned off.
the spreadsheet are included. These spreadsheets 6 2 16,000

are also available on Connect. Selected Exhibits 7 3 466,000

139
are set as Excel Spreadsheets. Calculating internal rate of return in Excel is as easy as listing the proj- (left), and then calculate IRR as we do in cell E4. As always, the interest
ect cash flows. For example, to calculate the IRR of the office-block rate is returned as a decimal.
project, you could simply type in its cash flows as in the spreadsheet

bre24962_ch05_128-177 139 12/08/15 03:23 PM

Check Point 8.3 Suppose the cash flow in year 3 is only $416,000. Redraw Figure 8.3. How would the IRR change?

Check Point 8.4 Suppose that a company invests $60,000 in a project. The project generates a cash inflow of
$30,000 a year for each of 3 years and nothing thereafter. For simplicity, we assume there are no
taxes.
Calculate the project’s internal rate of return. (If you do not have a financial calculator or spread-
sheet program, this will require a little trial and error.)
 Key Terms
annual percentage rates (APR) future value (FV) present value interest factor
annuity future value factor real interest rate
annuity due future value interest factor real value of $1
annuity factor growing annuity simple interest
compound interest growing perpetuity
xviii Preface discount factor
discount rate
inflation
nominal interest rate
effective annual interest perpetuity
rate (EAR) present value (PV)

END-OF-CHAPTER FEATURES Questions and Problems

Questions with online Excel templates or datasets are marked Third Pass
The end-of-chapter features offered to support with and can be found on Connect.

BASIC 5. Calculating Interest Rate. Find the interest rate

the concepts presented are Summary, Key Terms, 1. Present Values. Compute the present value of a implied by the following combinations of present
and future values: (LO4)
$100 cash flow for the following combinations of
Questions and Problems, Solutions to Check discount rates and times: (LO2) Present Value Years Future Value
a. r = 8%, t = 10 years Fourth Pass
Points, and Mini Cases. To help students achieve b. r = 8%, t = 20 years
c. r = 4%,
$400
$183
11
4
$684
$249
Chapter 22t = 10Credit
years Management and Collection 699
the stated learning objectives, the LO numbers d. r = 4%, t = 20 years $300 7 $300

2. Future Values. Compute the future value of a $100 6. Present Values. Would you rather receive $1,000
are included in both the Summary and theQuestions
Ques- and Problems cash flow for the same combinations of rates and
times
per year for 10 years or $800 per year for 15 years if
56 as in problem 1. (LO1) Part 1 Introduction a. the interest rate is 5%? (LO3)
tions and Problems. The Questions andQuestionsProb-with online Excel templates
3. Future Values. You deposit $1,000 into your bank
or datasets are marked
account. If the bank pays 4% simple interest, how
b. the interest rate is 20%? (LO3)
c. Why do your answers to parts (a) and (b) differ?
with and can be found on Connect. 21. Internet. Barclays Canada provides many of the CHALLENGE
lems incorporate questions requiring Internet much will you accumulate in your account after
exchange-traded funds listed on the TSX. Go to
10 years? If the bank pays compound interest, how
7. Present Values. What is the present value of
24. Internet. www.globefund.com,
Go tostream if the interest rate find
is “Fund
BASIC www.ishares.ca and explore 3 different ETFs. The the following cash flow
access, questions with guided steps, integrative much of your earnings will be interest on interest?
(LO1)
1. Trade Credit Rates. Company each X sells onouta the
1/20,
Filter” under “Inside Funds” in the middle of the
list is found on the home page under “Products.” For 5%? (LO3)page. Select an asset class that interests you. For
ETF, find name of the 5. Trade
market Credit Rates.
index that example,A firm
under currently
Years Cash Flow offers terms
the “Aggressive Growth” category,
questions, qualitative/conceptual questions, and Present the
net 60, basis. Customer 4.Y buys Values.
goods
If you earn
past5%
ETF isYou
with anwill
interest
returns, andon
require
replicating.
invoiceNote$700
your
fund funds,
fees.
in 5 top
the EFT’s years.
(LO2)how much
of5 sale
holdings,
of 3/20, net pick40.“Science
Whatand effect will theandfollow-
Technology,” click on “Get 1 $200
of $1,000. (LO2) ing actions have onResults.” Click on interest
the implicit each of the tabscharged
rate across the page 2 $400
questions requiring the use of Excel or an equiva-
a. How much can Y deduct
will you need to invest today in order to reach your
22. Internet. Go to www.theglobeandmail.com/
from
savings goal? the
(LO2)bill if it pays
globe-investor/funds-and-etfs/fund-lookup, to customers thatfunds.
and see what information is provided for the mutual
pass(LO3)
up the cash discount? State
3 $300

lent spreadsheet program. Questions are grouped on day 20?

b. How many extra days of credit
find “Fund Lookup.” Next, click on “Fund
cana Yfund
Select receive
whether
if itthen pick 3 funds
company,
Company.”the implicit
operated(LO2)
25. Internet.interest rateFund
Using the willFilter
increase or
from question 24,
decrease. find a mutual fund offering a similar investment
according to level of difficulty. passes up the cash discount? by the fund company and get the fund profiles for
each. Note the funds’ investment objectives, a. Thetop objective for each
terms are changed to 4/20, net 40. of the ETFs you found in
21. Compare the top 5 holdings, risks, past returns,
question
c. What is the effective annual 5rate of interest
holdings, risks, past if returns,
Y and fundb. fees.
The terms are and
Note changed to 3/30, net 40.of the07:43
bre24962_ch05_128-177 166 fund fees. Note the name11/16/15 index
PM chosen
pays on the due date rather than day of20?
the name the index chosen as the benchmark c. The for terms are as changed to 3/20,
the benchmark net 30. the mutual fund’s
for measuring
measuring the funds’ performances. (LO2)
Internet Problems 2. Terms of Sale. Complete the following passage by performances. (LO3)
23. Internet. We mentioned in Chapter 1 that large 26. Financial Markets. In most years, new issues of
selecting the appropriate terms banks fromhave thetheir
following
fingers in many INTERMEDIATE
pies. The Web sites stock are a tiny fraction of total stock market trading.
list (some terms may be used more of than once):
the very largest accep-banks are equally massive. The
Many problems are provided that are meant to be solved using the tance, open, commercial, trade, Royal Bank his
Canada, of Canadaor her 6. Trade Credit
(www.royalbank.com) and andIn other words, secondary market volume is much
Receivables. A firm offers terms
greater than primary market volume. Does the fact
Scotiabank (www.scotiabank.com) areof examples of
2/15, net 30. Currently, two-thirds of sell
all new
custom-
wealth of material available on the Internet. own, note, draft, account, promissory, bank, banker’s,
two of Canada’s largest banks with relatively straight-
that firms only
ers take advantage of the trade discount;
that the stock
occasionally
market
shares mean
the irrelevant
is largely remain- to the
the customer’s. (LO1) forward Web sites. Use these sites to find what financial manager? (LO2, LO3)
services banks provide to individuals, small busi- der pay bills at the due date. (LO5)
Most goods are sold on ____________________nesses, . In andthis case the a.LO4)
What will be the firm’s typical value for its trade
Excel Questions
large corporations. (LO2, LO3,
only evidence of the debt is a record in the seller’s receivables period? (See Section 20.2 for a review
books and a signed receipt. When the order is very of the trade receivables period.)
Excel questions, identified by an arrow icon in the margin, are avail- large, the customer may be asked Solutions
to signto Check
a(n) Points
____________________, b. What is the average investment in trade receivables
which is just a simple IOU. 2.1 An a.alternative
Corporationsissell forsecurities
the in the primary ifmarket. and invest savings. These financial institutions raise
annual salesmoneyare $20 million?
able for download on Connect. seller to arrange a(n) ____________________ ordering Thepayment
securities by
market.
are the later traded in the secondary
c. What would orlikely
in special ways, such as by accepting deposits
selling happen to the They
insurance policies. firm’s
not trade
only invest in
customer. In order to obtain the b.goods, the customer
The first public offering of shares by a corporation receivables period if itbut
securities changed
also lendits termstotobusinesses.
directly 3/15, They
must acknowledge this order and sign is itsthe document.
initial public offer. Any public offering of provide various other financial services as well.
Mini Cases This signed acknowledgment is known shares
asafter
a(n)that is a seasoned equity offer.
____________________.
c. The capital market is for long-term
net 30?
Terms the
7. financing,
2.4 Liquidity, risk reduction by investment in diversified
of Sale. Microbiotics currently sellsa all of itsfund, for
Sometimes the seller may also ask ____________________ bank to sign
money market for short-term financing.
portfolios of securities (through mutual
frozen dinners cash on delivery
informationbut believes it can
Integrative mini cases end many chapters. These allow students to the document. In this case it is known as a(n) ____________________.
d. The market for stocks versus the market for bonds
increase sales2.5
example),
by offering supermarkets
provided by trading.
oneavoid
month of
and other debt securities. Rhonda and Reggie need not high-dividend
3. Terms of Sale. Indicate which firm, of each pair,
apply their knowledge to relatively complex, practical situations. Sev- you would expect to grant shorter
2.2 Efficient diversification and professional management.
or longer credit
free credit. The price stocks.per They carton is $50the
can reinvest anddividends
the cost and keep
Pension funds offer an additional advantage, carton is $40.reinvesting
per because (LO5) until it’s time to pay the tuition bills.
eral new such cases have been added for this edition. periods: (LO4) investment returns are not taxed untila.withdrawn If unit sales will
(They will have to pay taxes on the dividends,
increase
however, whichfrom could1,000affectcartons to
their investment
a. One firm sells hardware; the from other thebread.
fund.
1,060 per month, should the firm offer
strategy. We discuss dividends andthe
taxescredit?
in Chapter 18.)
b. One firm’s customers have 2.3 anMutual funds are
inventory financial intermediaries that pool
turnover
and invest money raised from investors in The interest
portfo- 2.6 rate
It isisnot
1% apergoodmonth, and ifallthe
investment customers
opportunity cost
ratio of 10; the other’s a turnover of 15.
MARKET LEADING TECHNOLOGY c. One firm sells mainly to electric
lios of securities. Banks and insurance companies
are financial utilities;
institutions thethat do more than
will pay their ofbills.
b. just
What
capital is 15%. The investment offers only a 12%
pool if the interest
return. rate is 1.5% per month?
other mainly to fashion boutiques. c. What if the interest rate is 1.5% per month, but
4. Payment Lag. The lag between purchase date and the firm offers the credit only as a special deal to
the date at which payment is due is known as the new customers, while old customers continue to
terms lag. The lag between the due date and the date pay cash on delivery?
on which the buyer actually pays is termed the due 8. Credit Decision/Repeat Sales. Locust Software
lag, and the lag between the purchase and actual sells computer training packages to its business cus-
McGRAW-HILL CONNECT® payment dates is the pay lag. Thus
Pay lag = terms lag + due lag
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present value terms) is $95. Locust sells its packages
McGraw-Hill Connect® is an award-winning digitalState howteaching andthelearning
you would expect platform
following events to that gives
on terms students
of net 30 and estimates the
that means
about 7% of toall better
affect each type of lag: (LO5) orders will be uncollectible. An order comes in for
connect with their coursework, with their instructors,
a. The company and with
imposes thecharge
a service important
on late concepts that
20 units. The they
rate iswill
1% perneed
bre24962_ch02_033-056.indd 56
interest to know for
month. (LO5)
10/09/15 10:15 PM

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changes its terms from net 10istoa learning platform that continually adapts to
extended.
net 20. b. What is the break-even probability of collection?
individual students, delivering precisely what they need, when they need it, so class time is more engaging and effective.
Connect makes teaching and learning personal, easy, and proven.

CONNECT KEY FEATURES

bre24962_ch22_682-703.indd 699 01/06/16 06:51 PM

SmartBook®
As the first and only adaptive reading experience, SmartBook is changing the way students read and learn. SmartBook
creates a personalized reading experience by highlighting the most important concepts a student needs to learn at that
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simultaneously promoting long-term learning.

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Connect Insight is Connect’s new one-of-a-kind visual analytics dashboard—now available for instructors—that provides at-a-
glance information regarding student performance, which is immediately actionable. By presenting assignment, assessment,
 Preface xix

and topical performance results together with a time metric that is easily visible for aggregate or individual results, Connect
Insight gives instructors the ability to take a just-in-time approach to teaching and learning, which was never before avail-
able. Connect Insight presents data that helps instructors improve class performance in a way that is efficient and effective.

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INSTRUCTOR’S MANUAL
This supplement, completed by our authors, includes a descriptive preface containing alternative course formats and case
teaching methods, a chapter overview and outline, and key terms and concepts. Complete solutions to all end-of-chapter
problems are included.

COMPUTERIZED TEST BANK

For the computerized test bank, David Roberts of South Alberta Institute of Technology has adapted test questions that
consist of true/false, multiple-choice, and short-answer questions. Questions are identified by level of difficulty, and com-
plete answers are provided for all questions and problems, along with reference to the relevant chapter learning objective.

MICROSOFT® POWERPOINT® SLIDES

These visually stimulating slides—fully updated by Tanya Willis of Saint Mary’s University with colourful graphs, charts, and
lists—can be edited or manipulated to fit the needs of a particular course.

IMAGE GALLERY
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instructors’ PowerPoint slides. They allow you to
• Assign eBook readings and draw from a rich collection of textbook-specific assignments
• Access instructor resources, including ready-made PowerPoint presentations and media to use in your lectures
• View assignments and resources created for past sections
• Post your own resources for students to use
xx Preface

eBOOK
Connect reinvents the textbook learning experience for the modern student. Every Connect subject area is seamlessly inte-
grated with Connect eBooks, which are designed to keep students focused on the concepts key to their success.
• Provide students with a Connect eBook, allowing for anytime, anywhere access to the textbook
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ACKNOWLEDGMENTS
We take this opportunity to thank all those who helped us prepare this edition. We want to express our appreciation to the
instructors whose insightful comments and suggestions were invaluable to us during this revision.
We also want to extend much gratitude to you, the student using this textbook. Your criticisms and comments have
made each subsequent edition so much better. William Lim was a third-year B.Com. student at the University of Alberta
in 1985–86 and used the first-ever Canadian edition of a Brealey/Myers textbook in his introductory finance course taught
by Professor Gordon Sick, the Brealey/Myers/Sick/Whaley text Principles of Corporate Finance. It is our hope that, one day
in the not-too-distant future, one or several of you will likewise be inspired to adapt a Brealey/Myers text for Canadian
students.
We owe much to our colleagues at the University of New Brunswick and the School of Administrative Studies, York
University.
Thanks go to Professors Gopalan Srinivasan, Eben Otuteye, and Muhammad Rashid, University of New Brunswick, for
useful suggestions, and also to the Faculty of Business Administration, University of New Brunswick, for some research sup-
port on this project.
Additional thanks to Professors Razvan Boconcios and Rui Wang Miller, York University, for sharing their expertise and
assistance regarding IFRS, financial ratios, bond and stock valuation, and mergers and acquisitions.
We would like to express our appreciation to Navid Kheradmand and Alexandre Deslongchamps, University of New
Brunswick, for adept research and computational assistance. Additional thanks go out to Alexandre Deslongchamps for
work on some end-of-chapter problem solutions.
Furthermore, we are grateful to the following recent York University BAS graduates for their research assistance
and work on the end-of-chapter problems: Mashal Alassaf, Michael Baggetta, Jie Dang, Sanah Hasan, and Shengyuan
Stanley Zhu.
Thanks to Mariana Ionescu for the technical review of the text. In addition, we would like to thank our supplement
authors David Roberts and Tanya Willis, whose efforts will help students and instructors alike.
We are also grateful to the talented staff at McGraw-Hill Ryerson, especially Alwynn Pinard, Product Manager; Daphne
Scriabin, Product Developer; and Joanne Limebeer, Supervising Editor. We want to thank copy editor Rodney Rawlings for
his energetic attention to the details.
Devashis Mitra would like to extend heartfelt thanks to Elizabeth Maynes, his co-author on the previous four Canadian
editions, for her dedication, strong commitment, and hard work. Elizabeth was instrumental in putting together the chapter
on leasing, which is one of the unique and distinguishing features of the Canadian adaptation.
William Lim would like to express his gratitude to Elizabeth Maynes for initiating the comprehensive revision plan for
this Canadian edition.
Finally, we cannot overstate our indebtedness to Koumari Mitra, to Anusha Mitra, Devashis’ daughter, and to Brenda
Siok Hoon Tay-Lim and Nicolas Lim, William’s son. They supported us and forgave us when we were very absorbed in the
project.
Exploring the Variety of Random
Documents with Different Content
throat, suggested an emotion too deep and too sorrowful for such a
moment.
Again he had the curious sensation that the shade of Overton stood
between them, its outstretched hand thrusting Faunce away from his
bride and slowly but surely toward the edge of that frozen precipice
where he had left his comrade’s mortal body, abandoned without pity
and without help. At a moment when he should have been
supremely happy, Faunce was miserable. He had lifted the cup at
Circe’s banquet, and felt as if he had been transformed into some
hideous monster that must return to his lair.
Sitting beside Diane on the train, their close proximity accentuated
by the soft touch of her sleeve against his and by the faint, elusive
perfume of her hair, aware that his ring gleamed on the slender
finger of her left hand, he felt no thrill of exultation, only an intense
bitterness of soul. He could never look his wife in the face without
fear that she would read his soul, find the hideous secret hidden
there, and scorn him.
If some trick of fate, inexplicable as it was inexorable, had indeed
brought Overton back from the dead, Faunce could already foresee
the end. He began to thrash it over in his brain, to piece together
every fragment of news he had of the English expedition, and to try
to convince himself that it was humanly impossible for any of its
members to have been so near that they could have reached
Overton before he died. His own knowledge of the vast spaces of
those frozen regions went to strengthen his hope that he was safe.
He told himself, almost wildly, that it was not a hope that Overton
was dead, but that he himself was safe from public shame.
Diane, unaware of her bridegroom’s agony of mind, sat looking
deeply into the glow upon the far horizon. She had proudly accepted
his word; if he said that Overton was dead she must believe him.
She had not forced the issue by asking questions; she had assented
to what he said. As she looked out in silence, she was not thinking of
Faunce.
Then she became aware that he moved restlessly, and she turned
and met his eyes. The agony in them was so intense that she
started; but before she could speak, she saw it retreating, as if he
withdrew his soul from her sight. It struck a chill to her heart. The
look had been distraught, like a wild animal peeping out, and at the
alarm, rushing backward into its hiding-place.
“What is it, Arthur?” she exclaimed involuntarily.
Before he could reply a porter came through the train, holding up a
telegram and calling out the name—“Arthur Faunce!”
Faunce took the envelope nervously and tore it open, his face
changing perceptibly as he read the despatch.
“Our holiday is prolonged, Diane,” he said, turning to her with a
forced smile. “There’s been an accident in the shipyard, the ship
won’t be ready to sail for months. Instead of three weeks, it may be
three months.”
They had planned three weeks or so in Florida—a touch of the
tropical atmosphere before they began the long, hard voyage to the
antarctic. To his surprise she showed regret.
“I’m sorry, Arthur, I really want to go soon. To me it’s the great
adventure, and now we’ve months to wait! Shall you stay all that time
in Florida? I think I’m really a little sorry—even for that!”
He was not. Secretly he had long dreaded the arduous expedition,
the overwhelming presence that he must face—face with courage,
too, or fall forever in her eyes.
“For my part I’ll be glad of the rest. You see, I’ve been in those frozen
wastes, Diane, and I know we’ll need a stock of sunshine to carry
with us. And three months in Florida with you seems to me pretty
near Paradise!” As he spoke he smiled, and his dark eyes softened
with that charm which had gone so far to win her heart. Then he
added:—“But if you don’t want warm weather all the time, we’ll come
back north before we go. Wasn’t there some place—I think your
father suggested a cottage—where we could have at least ten days
of peace?”
She thought a moment, her eyes looking dark and dreamy under
their black lashes.
“It’s a little house of father’s. We could go there, of course, and I’ll
keep house. Yes, I think it would do you good, Arthur. You need rest
—I’ve seen how fagged you were. After the heat and sunshine that
bit of cool mountain air will brace you up. I should like it, too.”
Again he looked around at her. “Would you rather go there now?”
She shook her head. “I want our bit of Florida—and then this. We
can go quite easily, and not be out of reach of your last
arrangements, it’s in the Catskills, you know.”
“Where?”
She named a small place where the Herfords had long owned
property.
He hesitated, regarding her absently. She turned as she spoke, and
smiled. Her face seen thus, in the partial shadow of the car, between
daylight and dusk, had a peculiar charm, and her eyes held a
tenderness that went to his head.
“We’ll go, Diane!” he whispered softly, laying his hand over hers with
the first loverlike gesture he had used since they started.
“That’s settled then!”
She sank back in her corner, her face again shaded by her hat.
He was still thinking of their northern retreat.
“That name sounds familiar. Just where have I heard it before? I’ve
never been much in the Catskills.”
She did not answer for a moment, and he looked round at her; but
he could not make out the expression of her eyes, for they were bent
intently on the hand that he had just released.
“You know the name—very well, I fancy. Think a moment, Arthur!”
“I can’t remember.”
“I thought you would,” she said softly. “It’s only a little place, but—
Simon Overton was born there.”
Faunce made no reply at all. He sat quite still, looking steadily before
him at the people in the car. For the moment it was impossible to
meet her eyes.
 XIX
With Diane things had reached a climax long before that culminating
moment when she found that she had married not the man of her
imagination, but a strange, abstracted, sleepless creature whose
soul seemed to be retreating deeper and deeper into some hidden
recess of his being. Following out their early plans they had spent
months of waiting in Florida, but now the ship being nearly ready to
sail, they had come north and gone to the Catskills. During their long
stay at the south Diane had written occasionally to her father and
heard from him at even rarer intervals. The judge was a poor
correspondent and she noticed that he avoided any mention of the
continued rumors that Overton still lived. Now, in this last retreat,
even these rare letters stopped. Faunce had asked her to let their
last brief week in their sylvan cottage be uninterrupted, and they had
left no address behind them. They had spent six or seven days
together in the solitude of the mountains. The splendor of the sky,
which was already softening with the promise of summer, and the
soft purple of the infolding hills, had soothed her spirit, but they
seemed to have only increased a deep disquietude in Faunce.
He tried to hide it from her. She could see a kind of furtive
watchfulness in him that defeated any effort on her part to surprise
his confidence. The subtle feeling of distrust that had crept into her
reluctant heart leaped up whenever she saw his pale face opposite
her, even at table, and found that his eyes, handsome and luminous
as ever, avoided hers, or only met them with a sidelong glance from
under his long, girlish lashes. It was a glance that had an
indescribable effect of retreat, of slipping away, as if his soul evaded
daylight and the open, as some hunted animal might shun the
fellowship of its kind.
In this desire for isolation, he would not even allow a newspaper to
find its way to the house, and she was as completely cut off from the
world as if his love had marooned her on a desert island.
At first she had acquiesced in this peculiarity of his, had tried to
adjust her own keen and active mind to a period of quietude, to a
dropping away of the universe, that they might learn how to adjust
their own temperaments to each other and find a common ground on
which to establish their life together; but the longer she faced the
problem, the more difficult was its solution. She could not reconcile
herself to characteristics which she recognized as wholly divergent
from her own conception of the man.
He was not frank, as he had seemed to be, nor cordially disposed,
nor courageously bent on high endeavor. He was secret, complex,
and perilously evasive. He had never once, since their arrival in the
mountains, spoken the name of Overton; yet by the swift and
unerring instinct that comes to a woman at such moments, Diane
knew that his former leader was never out of her husband’s mind.
Overton it was who loomed between them, his shadowy arm
outstretched, as if, even from the bourn of the undiscovered country,
his spirit had arisen with new power and new divination.
Diane had accepted Faunce’s word. She had declared that she
would believe her husband; and no whisper from the world beyond
those shadowed hills had yet broken her resolution. But there were
moments—in the depth of night, or in the solitude of some early-
morning stroll—that made her heart sink. When she had hoped to
find candor and stability, she had encountered a silence as
perplexing as it was evasive.
It was a relief to her when, on the eighth or ninth day, he announced
his intention of returning to the city. They were sitting over a belated
breakfast, which Diane herself had prepared, with scant assistance
from the little mountain maid who had come to the Herford cottage to
help in their haphazard housekeeping.
The small dining-room, built for summer uses, jutted out from the
house, and was almost part of the large veranda which overlooked a
magnificent prospect. The scene, flooded with sunshine and touched
with the peculiar beauty of morning, lay before them in a panorama
of spring. The distant mountains, outlined against a brilliant sky, were
blocked out in every shade of violet and ocher, while near at hand
the brown woods of winter were exquisitely veiled in a delicate haze
of pale green and rose.
Here and there a wide glimpse showed a fallen tree spanning a
mountain brook; or some tall pine raised its dark-green shaft, like a
forest spire, pointing the way. In the wonderful clarity of the
atmosphere even the most distant objects stood out in vivid outline,
as if the whole scene had been painted by some Titan artist who had
used the universe for his canvas and the colors of heaven for his
brush. It had a fascination for Diane; it even comforted her, and she
sat looking at it, forgetful of the neglected meal.
She was a little startled when Faunce spoke.
“I think we’ve reached the end of it, Diane. We’ll have to begin to
face our great expedition. I’ve got to go to New York to-day.”
She looked up with a feeling of relief, but she met again that
retreating glance of his.
“I knew we couldn’t put it off much longer, Arthur. I’ve expected you
would be growing impatient as the days passed. But why to-day? It’s
such short notice! I shall have to close up everything at once.”
He pushed his cup aside, and she noticed for the first time that his
coffee was untasted.
“I got a telegram last night. I didn’t tell you.”
“I thought no one knew where we were,” she replied slowly, averting
her own eyes from the confusion that she could not help seeing in
his face.
“No one but Asher.” This was the man who was to serve under
Faunce in the new expedition. “I had to except him, of course. Last
night I got a despatch, and I must go to New York to-day; but you
needn’t be hurried, dear. I’ll come back to-night or to-morrow
morning, and we’ll have a day or two more together before we start.”
Diane understood now his frequent lonely strolls at nightfall. He had
gone to the post-office for mail that he had concealed from her. She
had a strange sensation, which involved no jealousy of her
husband’s private affairs. She felt as if the universe moved beneath
her feet, confirming her feeling, too, that there was some new and
impalpable barrier between them; but she made no sign of it.
Instead, she put her elbow on the table and rested her chin in the
hollow of her hand, while she regarded him with a quiet gaze.
“I wish you had told me!”
He moved restlessly in his chair.
“Why should I? It was such a simple thing to do—so obviously
necessary. I had to keep in touch with Captain Asher. Except for that,
you’ve been the whole world to me,” he added, with that subtle
gentleness which no man knew better how to use.
She smiled almost tremulously.
“I’m not jealous! Only——”
She rose abruptly and went to the window, looking out again on the
hills. He followed her and put his arm around her.
“Only what, sweetheart?”
She hesitated; then she turned and met his eyes. Their faces were
so close together that she felt his breath warm on her cheek.
“Only that I’ve felt, almost from the first, that there was no confidence
between us, Arthur. We’re not starting right. We can’t stand still—we
shall keep on growing either together or apart. You know it, I know it;
but there’s something—it’s like a veil, impalpable and yet
impenetrable—between us. What is it? Help me”—she half withdrew
herself from his arms and laid her hand lightly on his shoulder—“help
me to solve this riddle, dear, or——”
He was a little pale, but for the first time his eyes held hers, and she
was less conscious of the retreat in them.
“Or what?” he asked.
His tone seemed expressionless, yet her quick ear caught a guarded
note.
“Or we shall lose each other,” she finished bravely. “Don’t you see?
We’re two souls reaching out to each other through this thing that we
call love; but if we can’t find any meeting-point, we shall pass—our
two souls, I mean—like ships in the night! I’m not jealous, I’m not
curious, but I want to feel that you and I stand face to face in spiritual
confidence, that I know your heart as fully as I’ll try to make you
know mine!”
He snatched at the chance she gave him—a chance for evasion.
“Oh, I know it, Diane—it’s a heart of gold! Beside it mine seems as
commonplace as lead or pewter; but I love you—never doubt that—I
love you with all my soul!”
As he spoke, he folded her close with a reiterated protest of his
devotion. There was a moment of silence. Diane hid her face on his
shoulder.
It was useless to try to reach him. She knew it now—knew that in
protesting his affection with kisses and vows he had used the
commonest weapon of defense against a jealous woman. She
slipped out of his arms after a moment, and went back to the table,
quietly putting aside the little tray on which she had previously set
the samovar. He looked at his watch.
“I’ll have to go at once, dear, to get my train. No, I sha’n’t need any
bag, I’m coming back so soon.”
She looked over her shoulder.
“That’s all right, Arthur—don’t delay. I’ve got to see to so many
things, if we’re to break up in two days. But—you don’t mind now if I
write to father? You know I’ve kept the pact and remained in
mysterious retreat, but since your breaking it to-day I can, of course,
break it, too.”
She saw his hesitation, saw his face redden as he reached for his
hat and coat, but she waited quietly, offering no assistance of any
kind.
“Why, of course, Di, but”—he laughed weakly—“couldn’t you wait
until I come back?”
“Until to-night? Oh, if you wish it! But then I think I’ll call him up on
the long-distance. I should like to know just how he is.”
“Of course!” He came across the room to bid her an affectionate
good-by. “I hate to go—to break it up—but I must.”
She assented, and stood in the doorway, watching him walk rapidly
down the lane. At the end of it he turned and raised his hat, waving it
to her.
She returned to her housewifely duties, gave a few directions to the
little maid, and began to pack the few belongings that she had
brought with her. She was amazed at her own eagerness to go. They
had imagined much happiness in this quiet spot, but it had eluded
them. She knew that it had eluded Faunce, for he had scarcely slept
since they had been there, and his restlessness, his uneasy,
haunted look, had utterly broken down her own effort to be happy at
any cost.
She paused in her thoughts with a shock of feeling which flooded her
consciousness with a lucidity, an insight, that appalled her. Had they
both been disappointed? Had the torch of Psyche been lifted by
unsteady hands and fallen into an abyss between them?
Unable to endure her own thoughts, Diane thrust aside her work and
went out. She needed to escape the thraldom of four walls and try—
in the open—to vanquish the haunting spirits that might well have
escaped from the secret caverns of those lovely hills to assail her
with a fantom host of doubts.
She walked rapidly, avoiding the road to the little hamlet, and turning
into a path that led her past the old house where Overton was born.
At the moment she had not thought of it, but, as she approached, her
mind returned to him and to the strange report which had so startled
her wedding-guests. She thrust that away with an unconscious
gesture of pride. She would not distrust Faunce; and to believe that
Overton might still survive was to doubt his word. She battled against
that with all her remaining strength, and tried to concentrate her
thoughts on the beauty about her.
Summer was in the air, and the forces of nature, surviving the long
conflict with the bitter winter, had gathered themselves together in a
new and beautiful conquest of the earth. At her feet young blades of
grass thrust themselves up through the black loam with been new
life. The same rebirth seemed to breathe, too, in the tremulous
swinging of delicate boughs and the tasseling of magnificent foliage.
Overhead the crows flew by twos and tens and twenties, uttering
their harsh cries.
It was not tranquil, for the wind stirred restlessly in the branches. Far
off she heard the rush of a waterfall, and she could see the dark ring
of the encircling hills. It seemed to her that a great, unseen army
moved about her, and a mighty conflict was in progress. The dead
earth had reawakened; birth, not death, was here. The sap was in
the trees, and in the warm moss beneath her feet a myriad living
things were struggling up toward the sun.
She stopped suddenly and stood still. Below her, ascending the
same path, was the figure of a man. He was still a long way off, but
she caught the big outline, the deliberate but easy step, the peculiar
erectness of the head and shoulders.
She could not stir, but stood rooted to the spot, all the forces of life
suspended. It was impossible either to doubt her own vision or to
imagine that it was an apparition. The certainties of her own life
dissolved before this solution of the riddle that had tormented her
soul; for she knew, even before he approached her, that she stood
face to face, not with a specter from the frozen pole, but with the
living Overton.
A strange sensation, as if of personal guilt, overwhelmed her, and
she shrank back with an involuntary feeling of panic. He did not
observe it. He looked up, recognized her, and came forward with
outstretched hands.
“Diane!”
She commanded herself with a supreme effort.
“It’s—it’s really you?”
He was holding her hands now, smiling down at her, deeply moved.
“Did you think me a spook?” he laughed unsteadily. “It does seem
almost impossible. I’ve fairly come back from the dead! Did you get
my letter? I wrote you from London.”
“No—no, I’ve had no letter. I could scarcely believe that you had
come back!”
She was trembling; she saw the look in his eyes and knew that he
loved her. And how wasted he was, how pale! Here was a man who
had indeed been near to death. She fought for time.
“I had given up all hope long ago,” she faltered. “The others were
rescued; they believed you had been lost.”
As she spoke, she again raised her eyes to his, trying to find some
reassurance there, something that would refute the horrible fear that
wrung her heart; but what she saw made her look down, and a deep
flush mounted slowly and painfully over her pale face.
“I was as nearly dead as a man could be and live,” he answered
soberly. “I can feel the frozen horror of it now, the creeping
drowsiness—can see that bleak, inexorable wilderness where I was
deserted and left to die!”
He paused, as if the mere thought of it made utterance impossible,
as if he had faced a crisis so terrible and so deathlike that it must
remain forever inarticulate.
“Left to die!” she repeated in a broken voice, feeling that the very
earth sank beneath her feet. “Deserted! What can you mean?”
She was trying to be calm, but a nervous chill shook her from head
to foot. He saw it; he caught her hands in his again.
“Diane, you care!” he breathed with deep emotion. “What does
anything matter, then. I’ve come back and I’ve found you, my love,
my love!”
She swayed and he caught her in his arms, holding her, his wasted
face changed and lit with joy.
“Diane, I’ve come back to you!” he cried.
She pushed him away from her with both hands and stood, still
shaking, supporting herself against the vine-clad trunk of an ancient
oak.
“Don’t!” she gasped in a low voice. “You’ve made a mistake—I’m
married!”
There was a moment of intense silence. He straightened himself with
a shudder, like a man who had been shot but could still keep on his
feet.
“You’re married? And your—your husband, Diane—who is he?”
She watched him. She felt as if life itself hung on the look that she
would see in his eyes when she answered.
“Arthur Faunce,” she murmured in a low voice.
“Faunce!”
It was a cry of horror, of dismay—she could not mistake that.
Overton stood still, a deep color flaming up in his face. He was
apparently incapable of speech, but the look in his eyes, as they met
hers, was a revelation. It showed neither anger nor jealousy, but only
a deep and horrified consternation.
 XX
It was a long time before they left the spot where they had met.
Unconsciously and unbidden, he turned back with her. They were
silent. She could hear with extraordinary keenness every pebble that
crunched under his feet but she dared not look at him. She had a
strange sensation of suffocating in the open air. A rending fear shook
her, yet even at that supreme moment she had a rush of lucidity, a
remembrance of every word that Faunce had said.
He had been with Overton when he died—that much had been
clearly understood by all; and now, when they knew that Overton
was not dead, but had been rescued by the gallant English sailors
who had followed so closely on his track, what explanation
remained, what defense for Faunce?
“Where I was deserted and left to die!”
Overton’s words rang in Diane’s ears. Suspense was intolerable; she
must know the truth, even if the truth meant ruin. She forced herself
to speak.
“You said just now that you were deserted and left to die. Please tell
me what you meant!”
There was a perceptible pause before he answered.
“Did I say that? I”—he hesitated—“I’ve nearly forgotten what I said.”
She managed to raise her eyes to his face, and was relieved to find
that he was not looking at her. She felt like one lost in a trackless
desert. She must find a way out of it; she could not give up, could not
believe herself lost. If she did, she would perish. She forced herself
to speak again.
“But I haven’t forgotten. How could I? Will you tell me?”
He shook his head.
“Not now—give me a little time to think, please. You must know that
it’s all confused—I’ve been so ill and delirious. You mustn’t ask too
much of a sick man’s memory,” he ended lamely, trying to smile as
he turned at last and faced her.
She met his eyes and felt the full power of their love and their
renunciation. Their message was so clear that it made her feel faint.
She put her hand out involuntarily and caught at an intervening
branch, steadying herself.
He started toward her.
“What is it? You’re ill!”
She shook her head, recovering herself with an effort. She knew that
he was hiding from her something ruinous to her husband. There
was a second in which she still struggled with herself; then a strange
vicarious acceptance of guilt made her face burn. She had cloaked
herself with the iniquity of Faunce, if iniquity it was, and she could no
longer speak or act as a separate entity.
They began to descend the steep path again. This time the pebbles
tumbled ahead of them in a little shower as they scrambled down.
Diane tried to talk casually, not looking at Overton again.
“How is it you’re here, in this out-of-the-way place, so soon after your
return?”
“My aunt, my mother’s only sister, is living over there. She’s nearly
eighty, and she wanted to see me. I found her still in the black she’d
worn for me for months. It’s a strange thing to return from the dead! I
needed rest, too, just for a day or so.”
“You—look ill.”
He smiled.
“I’ve just pulled through; and yet it’s strange, isn’t it, the fever that
possesses me to go back! The lure is on me. It draws men back, I
suppose, to their doom!”
“It does—my husband is going again.”
“So they told me in New York. I was there a few hours. Of course the
newspapers besieged me, and I heard that much. Then I escaped.
That’s why I didn’t hear of—of your marriage.”
He was unable to maintain his tone, and his voice broke on the word.
She winced.
“It was a quiet wedding; not much was said about it. My father has
been ill.”
He expressed his regret, and asked for the latest news of the judge’s
health. She colored deeply.
“We haven’t written. It was agreed, when Arthur and I came up here,
that no one should write to us. You see, he’s been so much pursued
about everything! I’ve been shut up here, out of the world, and I
know nothing.”
He turned quickly, and their eyes met with a shock of feeling. She
knew intuitively that there was a reason why she had been kept in
the dark, and that he fathomed it and was indignant for her.
Once, when Overton was a lad, he had thrashed a comrade for
maltreating a lame dog. She had seen him do it, and she
remembered the look in his eyes. She saw the same look now,
flaming up in tranquil depths like a torch in the dusk.
She hurried on. A little ahead of him she could command herself; to
meet his look just now was more than she could bear.
“Shall you go down to Mapleton?” she managed to ask him. “The
Prices and Dr. Gerry will want so much to see you. So will papa—
you know that!”
“I did intend to go there at once; but now—yes, I suppose I shall. A
man goes home, doesn’t he, for the same reason that a cat returns
to the old house? It’s habit.”
“They’ll all be so glad to see you—you shouldn’t call it just habit to go
back there. It was—it is your home, isn’t it?”
He laughed a little bitterly.
“I haven’t a home in the sense that you mean. I think I’ll be
henceforth a nomadic creature. I’ve been away too long!”
She understood the bitterness in his tone, and she fought against the
wave of feeling that submerged her being. She had scarcely
dreamed that his voice could mean so much to her. The sound of it
brought back those old days when she had listened for it—the days
when Faunce had had no place in her thoughts, though now she was
his wife!
As she walked blindly on, hearing Overton’s step behind her once
more, feeling his presence, it seemed incredible that they were
separated forever, that her own act had made an impassable gulf
between them. She struggled with herself. She had believed in her
love for Faunce; she believed in it still. If she did not love him, why
should she suffer so deeply at the horrible doubt of him that had
assailed her? She loved him, she must believe in him, and—if she
could not believe in him—she must suffer with him.
They had reached a turn in the path. Below them lay a wild ravine
where a mountain stream tumbled over the rocks, lashed itself to
foam in its descent, and then dropped placidly into a wide pool,
where in summer the speckled trout darted in lovely shallows and
the water-lilies bloomed. Beyond, the hills rose one above another
until they darkened into the purple distance, piled like a mass of
heavy clouds against the deepening splendor of the western sky.
Near at hand, rising above some clustering evergreens, was the roof
of the little cottage that Judge Herford had built for an occasional
summer vacation. A white plume of smoke rose from the single
chimney in the center, and they could see the sun shining on the
window-panes.
“There’s the house,” Diane said, as lightly as she could. “I think papa
built it before you went away, didn’t he? It’s only a rambling affair, but
we’ve done very well there, and it’s really cozy and warm.”
“I knew it was here, but”—he hesitated—“it’s strange, isn’t it, that my
aunt never spoke of your being here?”
“Perhaps she didn’t know it. We’ve been very quiet.” She colored
again as she turned toward him. “Won’t you come in and take a cup
of tea? I can give you that—though we’re roughing it.”
He hesitated; then, aware, perhaps, that the moment was an
awkward one for both, he assented, and followed her down the last
slope to the road. They crossed the little bit of lawn together, and
Diane’s mountain maid opened the door for them. While she and her
mistress went to make tea for him, Overton entered the living-room,
and stood looking down at the few logs that were smoldering in the
big, open fireplace.
The room was quaint, planned much in the style of a shooting-lodge
that Judge Herford had visited abroad. A gun and a rod swung high
over the stone mantel-shelf. An old Turkey rug covered the floor, and
a couch in the corner suggested that it was sometimes used for an
unexpected guest.
On the table Overton saw an elaborate cigarette-case with the initials
of Arthur Faunce, and on the mantel, almost under his hand, was a
pipe that Faunce must have left there. Nearer, on a chair, were
tossed a bit of Diane’s needlework and her work-basket. They had
been sitting there together by that fireplace, husband and wife, the
woman whom Overton loved and the coward who had left him to
perish in those awful wastes!
The touch of intimacy, of actuality, drove the naked reality home.
Overton turned from the fireplace with a smothered groan and began
to pace the room.
The scene, warm, familiar, poignantly suggestive of her presence,
suddenly receded from his mental vision, and the illimitable snows
took its place. He saw again a slate-colored sky, a white and
dazzling waste, lofty peaks of bluish ice, and the face of Faunce
bending over his, distorted with sheer terror, the shrinking eyes
avoiding his, the lips blue. The howl of the antarctic blast seemed to
sweep over his very soul. He remembered the moment, fraught with
the bitterness of death, when, half-rousing from his stupor, he had
seen the coward go, when he had realized that the last means of
escape had been snatched from him, and that, helpless and
wounded, he must perish there alone.
Overton recalled his rage, his hatred of the man who had deserted
him, the violence of the spiritual struggle that had torn and wounded
his soul until, in one wild moment, he had almost cursed his Maker. It
was then, when he had nearly lost his hope of heaven, that he had
felt the rush of penitence, of faith. In that illimitable space a Greater
Presence had been revealed, and he had felt the gripping power of
things unseen and eternal. He had known that, though forsaken, he
was not alone; that a Spirit greater than the universe itself was with
him. He had cried aloud to God; and surely it was God who had
answered him.
Out of the stupor, the terrible frozen mist that had at last benumbed
him, body and soul, had come the rescue—the sound of human
voices, the touch of strong human hands—and he was saved. But
his anger against Faunce, his scorn of the traitor, had survived. Now,
as he tried to clear his recollection of it, Overton felt sore that he had
not spared him, but had told his rescuers the truth. He remembered
their indignation—the indignation that brave men feel against a
coward and a weakling.
Later, when the illness had left him, he had said less, had been
reserved in his references to Faunce, and he knew that on his
landing in New York he had refrained from describing the details of
his narrow escape from death. It was a chance, perhaps, that he had
not betrayed more, and he was thankful—thankful that, so far at
least, he had spared Diane; for Diane, as Faunce’s wife, must be the
one to suffer.
But could he do more to spare her? His mind was confused with the
horror of it. The loss of the woman he loved was bad enough, but to
see her the wife of such a man!
It was significant that even in that moment of despair his thought was
for her, and not for himself. He must shield her if he could. He must
save, if he could, her faith in the wretched man she had married; for,
if she loved Faunce, it would be the shipwreck of her life to see him
dishonored and exposed.
Presently he heard her returning, followed by the maid with the tea-
tray and the samovar. They came in together. Diane had removed
her hat and coat, and in her simple house-gown, her brown hair
rumpled by the wind, she looked almost as when Overton had seen
her last. There was the same delicate color in her cheeks, the same
elusive charm in her soft eyes under their straight, thick lashes, the
same white throat and brow, and yet how changed she was! He saw
it when she made tea for him and raised her eyes as she handed
him the cup.
“You’ll have to take cream and sugar,” she said with forced lightness.
“We’re truly ‘twelve miles from a lemon’ here!”
He took the cup with a smile, and sat down in a low chair by her tea-
table. The little maid threw another log on the fire and vanished. For
a moment there was no sound in the room but the crackle of the
flame as it licked up the dry bark of the new log. He looked at it
thoughtfully as he absently tasted his tea.
“It’s good to see a fire again. I don’t believe I’ll ever get past the joy
of feeling warm!” He forced a laugh. “Do you remember that late
autumn when we were all on the shore in Connecticut, and you and I
gathered driftwood?”
“Yes, and it was beautiful. What flames shot out! And have you
forgotten Mrs. Price and the ghost-story?”
They both laughed.
“She thought it wasn’t scriptural! How’s Fanny? She was in school
when I left.”
“She’s been out nearly two seasons, and she’s a very pretty girl.
Nothing could be more amusing than to see her with the dean and
her mother. They flutter behind her like two proud, fat sparrows
watching a fledgling.”
“The dean’s all right; he was good to me when I was a boy. How’s Dr.
Gerry?”
“Just the same!”