Preface
Financial economics is the study of markets for real and financial assets. The past three decades have witnessed
an unprecedented series of theoretical and empirical advances in our understanding of the markets, with
major breakthroughs in capital asset pricing under uncertainty, portfolio theory, valuation of options, and
response of security prices to corporate financial behavior. The practical implications of these breakthroughs,
commonly known as modern finance theory, are widely accepted and applied by finance practitioners.
Finance is concerned with the manner in which individuals and firms allocate resources across assets and
over time. The developed body of financial knowledge deals with portfolio decisions of individuals, with
investment and financing decisions by firms, and with the implications of such behavior for the pricing of
capital assets in the marketplace.
The goal of this book is to provide a rigorous understanding of how and why firms make their financial
decisions the way they do and their impact on shareholder value. The central theme of the book is Value
Based Management, which assumes that maximizing shareholder value is the governing objective of a firm.
This book examines the role of finance in supporting other functional areas while fostering an understanding
of how financial decisions can create value. Topics covered in this book are related to estimating divisional
cost of capital, executing a financing strategy, establishing debt and dividend policies consistent with the
company’s strategy and environment, choosing between dividends and stock repurchases, managing high
growth, and managing working capital.
When I set out on the second edition I had three things in mind:
- Provide rigorous yet managerially relevant introduction to finance theory.
- Build industry knowledge among readers.
- Critically test theory in realistic settings.
This led me to write this book through cases. A typical case requires instructions to instructors. To obviate
the need I have analyzed and written many real-life examples. For instance I have included two short cases
on financial statements along with solutions. At times I have integrated real-life managerial situations with
theory so that students can get a better picture of what they can expect to see in real life. I have also critically