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PPT 10-2
Chapter 10 - Outline
Valuation Concepts Valuation of Bonds 3 Factors that Influence the Required Rate of Return Relationship Between Bond Prices and Yields Preferred Stock Valuation of Common Stock Valuation Using the Price-Earnings Ratio Summary and Conclusions
PPT 10-3 / The relationship between time value of money, required return, cost of financing, and investment decisions
Figure 10-1
Chapter 10
Required rates of return by investors
Chapter 9
Present value concepts
Chapter 11
Cost of financing to the firm
Chapters 12 and 13
Analysis of projects based on cost of financing to the firm
Valuation
PPT 10-4
Valuation Concepts
The value or price of a stock or bond is based upon the present value of future expected cash flows to the investor
The discount rate used is investors required rate of return, based on the markets estimates of risk, efficiency, and expected future returns
PPT 10-5
Valuation of Bonds
The value of a bond is made up of 2 parts:
PV of the interest payments (an annuity) PV of the principal payment (a lump sum)
t =1
It Pn + (1 + Y ) t (1 + Y ) n
where : Pb = the market price of the bond It = the periodic interest payments Pn = the principal payment at maturity t = the period from 1 to n n = the total number of periods Y = the yield to maturity (required rate of return)
PPT 10-8
Bond prices are inversely related to bond yields (move in opposite directions) As interest rates in the economy change, the price or value of a bond changes:
if the required rate of return increases, the price of the bond will decrease if the required rate of return decreases, the price of the bond will increase
Table 10-1
PPT 10-7
PPT 10-6
represents the opportunity cost of the investment in the early 1990s, 5-7%, but now about 3-4%
Inflation Premium:
PPT 10-9
Table 10-2
0 . . . . . . . . 1 . . . . . . . . 5 . . . . . . . . 10 . . . . . . . . 15 . . . . . . . . 20 . . . . . . . . 25 . . . . . . . . 30 . . . . . . . .
Figure 10-2
PPT 10-10
30
25
PPT 10-11
Coupon
(April 8, 2022)
Maturity Date
BC Tel
9.65
6.488
+1.118
Price
(Closing Yield price up $1.12/ (Annual interest $100 from Market price) previous day)
Change
Approximate Yield
to Maturity
Principal -Price of the bond Annual interest payment + Number of years to maturity . 6 (Price of the bond) +.4( Principal payment)
PPT 10-12
usually represents a perpetuity (something with no maturity date) has a fixed dividend payment is valued without any principal payment since it has no ending life is considered a hybrid security owners have a higher priority of claim than common shareholders price is based upon PV of future dividends
Dp
Dp
Dp
PPT 10-13
The value of common stock is the present value of a stream of future dividends Common stock dividends can vary, unlike preferred stock dividends There are 3 possible cases:
No growth in dividends (valued like preferred stock) Constant growth in dividends Variable growth in dividends
Required rate of return reflects the dividend yield on the stock and the expected growth rate in the dividend
D3 D1 D2 D + + + + (1 + K e )1 (1 + K e ) 2 (1 + K e ) 3 (1 + K e )
Dt Pn Dt = + = t (1 + K e ) n t =1 (1 + K e ) t t =1 (1 + K e )
No growth in dividends
P0 = D0 Ke D1 Ke g
PPT 10-14
the earnings and sales growth of the firm the risk (or volatility in performance) the debt-equity structure the dividend policy the quality of management a number of other factors
The average P/E ratio for TSX Composite, excluding Nortel and JDS Uniphase, in early 2002 was 33 to 1
PPT 10-15
Table 10-4
PPT 10-16
PPT 10-17
Volume
Close
(Highest price paid per share for the day was $29.15)
High
Inco
3760
29.150
28.500
28.600
-.400
(Lowest price paid per share for the day was $28.50)
Low
Change
PPT 10-18
D0 (1 + g s ) t D0 (1 + g s ) n P0 = + t (1 + K e ) ( K e g c )(1 + K e ) n t =1
n
Figure 10B-1
PPT 10-19
PPT 10-20
The value of securities is based upon the present value of expected future cash flows from the investment, discounted at the rate of return required by investors The required rate of return includes premiums for expected inflation and the perceived risk of the investment
The price of a bond reflects the present value of future payments of interest and principal, discounted at current market bond yields The price of a preferred or common stock reflects the present value of future dividends, discounted at current market dividend yields An alternative for valuing common stock is the price-earnings ratio