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# Cf Valuation Of Securities 5

## by rajeevgupta on Apr 11, 2008

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FINANCE,CFM

FINANCE,CFM

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## Cf Valuation Of Securities 5Presentation Transcript

• Valuation of Long Term Securities
• What is a cynic? A man who knows the price of everything and the value of nothing.
• Oscar Wilde
• Valuation
• Liquidation value
• Book value
• Market value
• Intrinsic value
• Discounted Cashflow Model
• The value of an asset is the present value of its expected cashflows discounted at a risk adjusted required rate of return.
• Discounted Cashflow
• V = C 1 /(1+r) + C 2 /(1+r) 2 + C 3 /(1+r) 3 +….+
• (C n + M) / (1+r) n
• Required Rate of Return
• Time
• Inflation
• Risk
• All securities in an equivalent risk class are priced to offer the same expected return.
• Bond Valuation
• Face value
• Coupon rate
• Maturity
• Future cashflows
• Bond Valuation
• V = C 1 /(1+r) + C 2 /(1+r) 2 + C 3 /(1+r) 3 +….+
• (C n + M) / (1+r) n
• Where C 1 …..C n are the coupon payments, M is the maturity value.
• r is the discount rate and V is the value of the bond.
• Bond Valuation
• V = C* PVIFA r,n + M * PVIF r,n
• Rs 100 FV. 10% coupon. 9 years maturity.
• 12% discount rate.
• = 10 * PVIFA (12%.9years) + 100 * PVIF(12%.9years)
• = 10 *5.328 + 100 * 0.361 = 89.38
• 8% discount rate.
• = 10 * PVIFA (8%.9years) + 100 * PVIF(8%.9years)
• = 10* 6.247 + 100 * 0.5 = 112.47
• Zero Coupon Bond
• No periodic payment of interest. Sold at discount to face value.
• V = Maturity value * 1/ (1+r) n
• = Maturity value * PVIF r,n
• 1000 FV. 10 years. 12% discount rate.
• Value = 1000 * 0.322 = Rs 322
• Perpetual Bonds
• A bond that does not mature and hence, pays constant interest forever.
• V = C/ r
• Yield to Maturity
• The discount rate that equates the present value of all the future cashflows of the bond to the current market price
• Interest rate risk. Relationship between interest rate and bond prices
• Valuation of shares
• Value of a share equals the present value of expected future dividends.
• Dividend Discount Model
• Valuing Common Stocks
• Expected Return - The percentage yield that an investor forecasts from a specific investment over a set period of time. Sometimes called the market capitalization rate .
• Valuing Common Stocks
• Example: If Fledgling Electronics is selling for \$100 per share today and is expected to sell for \$110 one year from now, what is the expected return if the dividend one year from now is forecasted to be \$5.00?
• Valuing Common Stocks
• The formula can be broken into two parts.
• Dividend Yield + Capital Appreciation
• Valuing Common Stocks
• Price = P 0 =(Div 1 + P 1 )/ (1+r)
• Current price based on forecasted dividend, forecasted price and discount rate
• Valuing Common Stocks
• Dividend Discount Model - Computation of today’s stock price which states that share value equals the present value of all expected future dividends.
• H - Time horizon for your investment.
• Valuing Common Stocks
• Example
• Current forecasts are for XYZ Company to pay dividends of \$3, \$3.24, and \$3.50 over the next three years, respectively. At the end of three years you anticipate selling your stock at a market price of \$94.48. What is the price of the stock given a 12% expected return?
• Valuing Common Stocks
• Example
• Current forecasts are for XYZ Company to pay dividends of \$3, \$3.24, and \$3.50 over the next three years, respectively. At the end of three years you anticipate selling your stock at a market price of \$94.48. What is the price of the stock given a 12% expected return?
• Valuing Common Stocks
• If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY .
• Valuing Common Stocks
• If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY .
Assumes all earnings are paid to shareholders.
• Valuing Common Stocks
• Constant Growth DDM - A version of the dividend growth model in which dividends grow at a constant rate (Gordon Growth Model) .
• Valuing Common Stocks
• If the same stock is selling for \$100 in the stock market, what might the market be assuming about the growth in dividends?
Answer The market is assuming the dividend will grow at 9% per year, indefinitely.
• Valuing Common Stocks
• If a firm elects to pay a lower dividend, and reinvest the funds, the stock price may increase because future dividends may be higher.
• Payout Ratio - Fraction of earnings paid out as dividends
• Plowback Ratio - Fraction of earnings retained by the firm.
• Valuing Common Stocks
• Growth can be derived from applying the return on equity to the percentage of earnings plowed back into operations.
• g = return on equity X plowback ratio
• Valuing Common Stocks
• Our company forecasts to pay a \$5.00 dividend next year, which represents 100% of its earnings. This will provide investors with a 12% expected return. Instead, we decide to plow back 40% of the earnings at the firm’s current return on equity of 20%. What is the value of the stock before and after the plowback decision?
• Valuing Common Stocks
• Our company forecasts to pay a \$5.00 dividend next year, which represents 100% of its earnings. This will provide investors with a 12% expected return. Instead, we decide to blow back 40% of the earnings at the firm’s current return on equity of 20%. What is the value of the stock before and after the plowback decision?
No Growth With Growth
• Valuing Common Stocks
• Example - continued
• If the company did not plowback some earnings, the stock price would remain at \$41.67. With the plowback, the price rose to \$75.00.
• The difference between these two numbers (75.00-41.67=33.33) is called the Present Value of Growth Opportunities (PVGO).
• Valuing Common Stocks
• Present Value of Growth Opportunities (PVGO) - Net present value of a firm’s future investments.
• Sustainable Growth Rate (g) - Steady rate at which a firm can grow: plowback ratio X return on equity.
• Price Earnings Ratio
• Relationship of growth with P/E ratio
• Shareholder value created thru investments that yield returns in excess of COC
• Growth vs Return
• ROIC Growth P/E
• Growth Inc 14% 13% 17
• Returns Inc 35% 5% 17