Professional Documents
Culture Documents
Valuation
Concepts
2005 Thomson/South-Western
Basic Valuation
The Time Value of Money = the value of
anything is based on the PV of the CFs the
asset is expected to produce in the future.
Asset
^
CF
^
CF
^
CF
V 1
2
N
value 1 k 1 k
1 2
1 k N
N
^
CF
t k = required return-- based on
2
Valuation of Financial Assets: Bonds
Key Inputs
Cash Flows
Timing
RRR (RISK) the greater the risk of the CF the
lower its value
CAPM: the greater the risk the greater the
RRR (Discount rate)
3
Valuation of Bonds
Principal, Face/Maturity/Par Value: borrowed and
promised to repay at future date, often at maturity.
Coupon Payment: The specified $ of interest paid
each period (6 months).
Coupon Interest Rate: The stated annual rate of
interest paid on a bond.
Maturity Date: Repayment date of the par value
Original Maturity: the years to mat. at issued date
Call Provision: right to pay off bonds prior to mat
4
Bond Value:
10 yr bond, BD1000 FV, 10% coupon rate
INT M
V N
d
t 1
1 k t 1 k N
d d
OR: Vd = (INTt x PVAIFt) + (Mn x PVIFn)
kd = RRR on a debt instrument
N = no. of years before the bond matures
INT = dollars of interest paid each year (Coupon rate x Par value)
M = par/face value of the bond to be paid off at maturity
5
Fin 320 Dr. B. Asiri - 2010 Class work 2 - Bond Valuation
You have decided to invest in 10-year bond with a face value of BD1000 and a coupon rate of 10%.
a) Compute the present market value for the bond.
b) If you held the bond for two years, what is the new market value?
c) Suppose due to some economic conditions the rate of interest dec to 8%, what is the new mkt value?
d) Suppose the required rate is constant over the life of the bond, compute the present mkt value for the bond for the
period 10 to maturity.
e) If due to some economic pressure the rate of interest inc to 12%, what will be the mkt value?
f) If the required return is constant over the period of the bond, compute the mkt value of the bond for years 10 to 0.
If market rate = coupon rate, the bond will sell at par value.
If market rate > coupon rate, the bond will sell at discount.
If market rate < coupon rate, the bond will sell at premium.
7
Year kd = 10% kd = 15% kd = 20%
0 $1,380.30 $1,000.00 $766.23
1 $1,368.33 $1,000.00 $769.47
2 $1,355.17 $1,000.00 $773.37
3 $1,340.68 $1,000.00 $778.04
10
Finding the Interest Rate on a
Bond: Yield to Maturity
12
Valuation of Equity (common stock)
What is a stock?
Ownership of a company
Dividends (Expected and current)
Capital gain (Future > current price)
Expected price
Required, actual and expected returns
Factors affecting stock price
Managers action
EPS
Inflation
EXPECTATION
others 13
Stock Valuation Models:
Key terms
D t E(dividend ) to be recieved at the end of yr t
D 0 the recent dividend paid
D1 the next E(dividend ) to be paid (end of this yr)
D 2 E(dividend ) at the end of two years
All future dividends are expected values, ...
estimates may differ among investors.
14
Stock Valuation Models:
Key terms
P0 current market price
P0 the value of an asset that , in the mind
of an investor, is justified by the facts;
may differ from the asset' s current
market price, its book value , or both.
Pt the E(price) at the end of each yr t.
g E(rate) of change in dividends per share.
15
Stock Valuation Models:
Key terms
ks the min rate of return given its risks and returns
D1 P1 P0
Dividend yield Capital gain
P0 P0
k s the E rate of return on a common
stock an investor expects to receive
D1 P1 P0
P0 P0
ks rate of return investor actually receives,
dividend yield capital gains yield
16
Expected Dividends as
the Basis for Stock Values
17
Expected Dividends as
the Basis for Stock Values
D1 D 2 D
P0
1 k s 1
1 k s 2
1 k s
D t
t 1 1 k s t
18
Stock Values with Zero Growth
A Zero Growth Stock is a common stock whose
future dividends are not expected to grow at all.
g 0, and D 1 D 2 D D 0
D D D
P0
1 k s 1 k s
1 2
1 k s
D
Perpetuity
ks 19
Normal, or Constant, Growth
(Gordon Model)
g = a constant
D 0 1 g 1
D 0 1 g 2
D 0 1 g
P0
1 k s
1
1 k s 2
1 k s
D 0 1 g D1
ks g ks g
20
Expected Rate of Return on a
Constant Growth Stock
Dividend yield (Expected)
Expected growth rate, or capital gains yield
D1
k s g
P0
21
Valuing Stocks: Nonconstant Growth
Nonconstant Growth: The part of the life
cycle of a firm in which its growth is either much faster
or much slower than that of the economy as a whole.
23
The Efficient Markets Hypothesis
The weak form of the EMH states that all
information contained in the past price
movements is fully reflected in current
market prices.
The semistrong form states that current
market prices reflect all publicly available
information.
The strong form states that current market
prices reflect all pertinent information,
whether publicly available or privately held.
24
Changes in Stock Prices
25
Valuation of Real
(Tangible) Assets
^
Year Expected Cash Flow, CF
1 $120,000
2 $100,000
3 $150,000
4 $80,000
5 $50,000