Beruflich Dokumente
Kultur Dokumente
Valuation Concepts
Valuation of a financial asset is based on
determining the present value of future cash
flows.
Required rate of return (the discount rate)
Depends on the markets perceived level of risk
associated with the individual security.
It is also competitively determined among companies
seeking financial capital.
Implying that investors are willing to accept low return
for low risk and vice versa.
Efficient use of capital in the past results in a lower
required rate of return for investors.
10-3
10-5
Inflation Premium
Compensation towards the negative effect of
inflation on the value of a dollar.
Premium added to the real rate of return:
Ensures that the investor will not pay the borrower to
use his or her funds.
The risk-free rate of return can be determined.
10-6
Risk Premium
Towards special risks of an investment.
Business risk: inability of the firm to retain its:
Competitive position.
Maintain stability and growth.
10-7
10-8
10-9
10-10
10-11
5-12
$31.875
$31.875
$31.875
$1,031.875
6 / 30 / 09
12 / 31 / 09
1 / 1 / 05
6 / 30 / 05
12 / 31 / 05
5-13
Valuation of Bonds
A bond provides an annuity stream of
interest payments and a principal payment
at maturity.
Cash flows are discounted at Y (yield to maturity).
Value of Y is determined in the bond market.
The price of the bond is:
Equal to the present value of regular interest
payments.
Discounted by the yield to maturity added to the
present value of the principal.
10-14
Valuing a Bond
Example
If today is January 2004, what is the value of the following
bond?
A German Government bond (Bund) pays a 5.375 percent
annual coupon, every year for 6 years. The par value of the
bond is 100 EURO.
Cash Flows
'05
'06
'07
'08
'09
'10
5.375 5.375 5.375 5.375 5.375 105.375
Valuing a Bond
Example continued
If today is January 2004, what is the value of the following bond?
A German Government bond (Bund) pays a 5.375 percent annual coupon, every
year for 6 years. The par value of the bond is 100 EURO.
The price at a 3.8% YTM is as follows
5.375
5.375
5.375
5.375 105.375
PV
2
3
4
5
1.038 1.038
1.038 1.038 1.038
$108.31
Valuing a Bond
Example continued
If today is January 2004, what is the value of the following bond?
A German Government bond (Bund) pays a 5.375 percent annual coupon, every
year for 6 years. The par value of the bond is 100 EURO.
The price at a 2.0% YTM is as follows
5.375 5.375
5.375
5.375 105.375
PV
2
3
4
5
1.02 1.02
1.02 1.02 1.02
$118 .90
$0
$0
$0
$F
T 1
PV
(1 r )
5-18
$0
$0
$1,000
0$ 0,1$
0 1229 30
29
30
F
$1,000
PV
$174.11
T
30
(1 r )
(1.06)
5-19
Level-Coupon Bonds
Information needed to value level-coupon bonds:
Coupon payment dates and time to maturity (T)
Coupon payment (C) per period and Face value (F)
Discount rate
$C
$C
$C
$C $ F
T 1
C
1
F
PV 1
T
r
(1 r ) (1 r )T
5-20
$31.875
$31.875
$31.875
$1,031.875
6 / 30 / 09
12 / 31 / 09
1 / 1 / 04
6 / 30 / 04
12 / 31 / 04
$31.875
1
$1,000
PV
1
$1,070.52
12
12
.05 2
(1.025) (1.025)
5-21
2.
3.
4.
5-22
5-23
Bond Value
1300
1200
1100
1000
800
0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09 0.1
6 3/8
Discount Ra
5-24
Bond Value
Par
Short Maturity
Bond
Discount Ra
Long Maturity
Bond
5-25
Bond Value
High Coupon
Bond
Discount R
Low Coupon Bond
Price
Yield
10-27
10-28
Where,
= the price of the preferred stock;
= the annual dividend for the
preferred stock (constant);
= required rate of return (discount rate)
applied to preferred stock dividends.
10-29
If the rate of return required by security holders change, the value of the
preferred stock also changes.
The longer the period of an investment, the greater the impact of a
change in the require rate of return.
With perpetual security, the impact is at a maximum.
Assuming that the required rate of return has increased to 12%. The
value of the preferred stock would be:
If it were reduced to 8%, the value of the preferred stock would be:
10-30
Trading of Stocks
Primary Market
Secondary Market
52 weeks
High
Low
Stock (SYM)
Div
Yield
PE
Vol
(100s)
Close
Net
Change
3449
1876.4
Infosys
(INFOSYSTCH)
0.2%
39.52
1539
3177.9
1.4%
Div1
EPS1
Perpetuity P0
or
r
r
Assumes all earnings are
paid to shareholders.
Rs.3.00
Rs.100
.12 g
g .09
Answer
The market is
assuming the dividend
will grow at 9% per
year, indefinitely.
Div1 P1 P0
Expected Return r
P0
5 110 100
Expected Return
.15
100
Div1 P1 P0
Expected Return r
P0
P0
Div1
Capitalization Rate P0
rg
Div1
r
g
P0
Div1
Dividend Yield
P0
Return on Equity ROE
EPS
ROE
Book Equity Per Share
Div1
Div2
Div H PH
P0
...
1
2
H
(1 r ) (1 r )
(1 r )
H - Time horizon for your investment.
3.00
3.24
3.50 94.48
PV
1
2
3
(1 .12) (1 .12)
(1 .12)
PV Rs.75.00
5-48
Div1
Div2
Div3
P0
1
2
3
(1 r )
(1 r )
(1 r )
Div
P0
r
5-49
Div3 Div
. 2 (1 g) Div0 (1 g)
.
.
P0
r g
5-50
Div Div (1 g )
1
.
.
.
.
.
5-52
Div0 (1 g1 ) Div0 (1 g1 )
N
Div0 (1 g1 )
DivN (1 g2 )
Div0 (1 g1 )N (1 g2 )
N+1
5-53
C
(1 g1 )
PA
r g1
(1 r )
T
N 1
r g2
PB
N
(1 r )
5-54
DivN 1
C
(1 g1 )T r g2
P
1
T
N
r g1
(1 r )
(1 r )
5-55
5-56
C
(1 g1 ) r g2
P
1
T
N
r g1
(1 r )
(1 r )
$2(1.08)3 (1.04)
(1.08)
.12 .04
$
2
(
1
.
08
)
1
P
3
3
.12 .08
(1.12)
(1.12)
$32.75
P $541 .8966
3
(1.12)
P $5.58 $23.31
P $28.89
5-57
$2(1.08) $2(1.08)
0
$2.16
0
$2.62
$2.52
.08
$2.33
2
P3
The constant
growth phase
beginning in
year 4 can be
valued as a
growing
at
$2perpetuity
.62
time
$32.75
3.
.08
$28.89
P0
2
3
1.12 (1.12)
(1.12)
5-58
5-59
5-60
5-61
No Growth
8.33
P0
Rs.55.56
.15
With Growth
5-66
Div1
$1.50
$75
P0
r g .16.14
5-67
Div1 $5
$31.25
P0
r
.16
.20
3
.
50
3.50 .16
$.
875
$43.75
P0
r g
.16.14
Pricepershare
P/E ratio
EPS
Firms whose shares are in fashion sell at high multiples. Growth
stocks for example.
Firms whose shares are out of favor sell at low multiples. Value stocks
for example.
5-69
Price/Sales
current stock price divided by annual sales per
share
Gap pays a
dividend of 9
cents/share
Given the
current price,
the dividend
yield is %
Gap has
been as low
as $19.06 in
the last year.
6,517,200 shares
traded hands in the
last days trading
5-71
5.10
(1 r )
C
2. The value of a perpetuity is
PV
r
5-73
1
1 T
(1 r )
F
T
(1 r )
The yield to maturity (YTM) of a bond is that single rate that discounts
the payments on the bond to the purchase price.
5-74
g1 ) r g2
C
(
1
P
1
T
N
r g1
(1 r)
(1 r)
5-75
EMBA 1, BUP
Maj Yeaseen
10-78
10-79
10-81