Inflation Consumption Preference A Real Return

Free Cash Frictionless money market: Lending & Borrowing Rate Equal Risk-free No borrowing or lending limit Cash flows at fixed time intervals

Single Amount (Lump Sum) Annuity (Series of Equal amount) Equal amount to Perpetuity Unequal Cash Flows Constantly Growing amount to Perpetuity

Seek out

For basic time value problems, you will need 4 input values. If you know 3, you can find the 4th variable. For Bond valuation, you will need 5 input variables. You need to know 4 to find the 5th value. Suppose there is Taka 12,00,000 in an account today. No money was taken out and no money deposited into the account in the last four years. If the interest rate in the account is 10.25%, how much was in the account 4 years ago?

Present Value (PV) (Amount at the beginning of a time line) Future Vale (FV) (Amount at the end of a time line) Payment (PMT) (Amount of Annuity) Interest/Discount/Reinvestment Rate (I) Length of time Period (N)

Semi-annual Quarterly Monthly Daily Continuously Less frequent than annual

At What Rate Money Must Grow to Make Sure That you Will Have Taka 1 Crore If You Save Taka 50,000 per year for 30 Years? At 12 Percent, How Much Must You Save Per Year to Have Taka 1 Crore in 30 years?

Paying off a loan in Equal Annual Installments

Interest and Balance Due declines as time elapses Payment of Principal Portion increases with Time.

Roger will deposit Taka 12,500 every year at the end of the year beginning this year until he accumulates Taka 70,000. Interest rate in the account in 12%. How many years will he need to accumulate the target amount? What will be the size of last deposit?

You are 30 years old and have a decent job. You will work for 35 more years. You will start saving this year and make a deposit into a retirement account every year until you retire. The interest rate in this account is 9.8% per year. After you retire, you will live exactly 10 years. Your current living standard requires Taka 4,80,000 per year. Inflation is 7.5% per year. When you retire, you will maintain the same living standard. For simplicity, assume that you will need the same amount every year after you retire (that is, no inflation adjustment after that). Question 1. How much do you have to accumulate in the retirement account when you retire? Question 2. How much do you have to save per year?

Rearrange The FVi,n Equation

PV = FVi,n / (1+i)n = FVi,n * (1/(1+i)n)

Using the PVIF Table

What happens as time lengthens What happens as I increases

Figure 2: PVIF: Present Value of Taka 1

1.2 1 0.8 0.6 0.4 0.2 0 Discount Rate 5% Discount Rate 10% Discount Rate 15% Discount Rate 20%

PVIF

PVIF Gets Smaller for Distant Amounts and Higher Rates

Ye ar 0 Ye ar 2 Ye ar 4 Ye ar 6 Ye ar 8 Ye ar 10
Time

Present Value of An Annuity of Taka 1 PVAi,n = 1(1/(1+i)1) + 1(1/(1+i)2)+ + 1(1/(1+i)n) n n = PVAi,n = 1 (1/(1+i)t) = (1/(1+i)t) t=1 t =1

Find Individual Present Values Sum the Present Values What about simply using the CF function of your calculator? Finding FV of Unequal Flows by converting The PV of Unequal Flows to A FV.

PV = Pft / (1+i)t t=1 PV = Pf / i PV = CF/i

PV = CFt(1+g)/(k-g)
g must be smaller than k

Chapter 5 The General Procedure of valuation of any financial instrument

Identify Cash flows

Annuity component (PMT) Maturity Value, A Single Amount (FV)

Discount Rate: The Required Rate, (I/Y) Time Frame (N)

V = Pmt/(1+r)t + M/(1+r)n

Consider a 10 year bond with an annual coupon rate of 12% paid annually and has a face value of Taka 1,000. Discount rate is 14%. What is the value of such a bond now?
Annuity (PMT) = 120 Number in the Series (N) = 10, Maturity Value (FV) = 1000 Discount Rate (I/Y) = 14%

Zero Coupon Bonds Have no Annuity.

If a firm issues a 20 year zero coupon bond when the market yield is 12%, how much will the firm raise per bond? If the firm issues 100,000 such bonds, what is the total amount the firm will raise? What is the total payment obligation when the bond matures?

The Rate of Return You Lock in if You Buy The Bond Today and Hold It till Maturity Easiest Way to Calculate is to Use Financial Calculator YTM = Current Yield + Capital Gain Current Yield (CY) = Coupon/Purchase Price Capital Gain (g) = (Current Price-Initial Price)/Initial Price

For non-convertible, non redeemable Preferred Stock: Claim to A Perpetuity Vpr = Dpr/rpr

Constant Dividend Stocks(Perpetuity) Dividends Growing at A Constant Rate(constant growth to infinity) Dividend is not Constant, The Growth Rate is Not Constant

Very Much Like Infinite Life Preferred Stocks

P0 = D/k

Rearrange to Find Expected Return k = D/Po

Gordon Growth Model

P0 = [D1(1+g)t/(1+r)t] t=1 P0 = D1/(k-g) = D0(1+g)/k-g
n

Four Steps
Forecast Dividends until Dividend Growth

Becomes Constant and Stable Find the Expected Price when Dividend Growth Becomes Stable Project the Cash Flows (Dividends Plus Expected Price) till Dividend Becomes Stable Find The PV of Cash Flows

Majestic Corporation is expected to pay a dividend of Taka 10 two years from now. Dividend will increase at 50% in the 3rd year, 25% in the fourth year and then will grow at a constant rate of 8%. If stockholders require a return of 16% on this stock, what is the fair value of the stock?

Dividend Projections D1 = 0 D2 = Taka 10 D3 = Taka 15 D4 = Taka 18.75 D5 = Taka 20.25 Price Projection P4 = D5/(k-gn) = Taka 20.25/(.16-.08) = Taka 253.125. Cash Flows: CF1 = 0 CF2 = Taka 10 CF3= Taka 15 CF4 = Taka 18.75+253.125 Po = Taka 167.20

Dividend Yield = Expected Dividend/Po

Capital Gains = (Expected Price Initial price)/Initial Price. Compute the dividend yields and capital gains in each of the next four years in the previous example.

Required Return and Expected Return Equal If Required Return>Expected Return: Stock Is Overvalued If Required Return<Expected Return: Stock Is Undervalued

Historical Growth in Dividend Historical Growth in Return on Equity GNP Growth National Inflation Regression Slope Asset Growth (Especially for Financial Institutions) Retention Growth= ROE(1-Payout Ratio)