6. Defining Value
1. Book value is the value of an asset as shown on a firmโs balance
sheet.
2. Liquidation value is the dollar sum that could be realized if an asset were sold
individually and not as part of a going concern (a company has the resources needed
in order to continue to operate indefinitely)
3. The market value of an asset is the observed value for the asset in the marketplace.
This value is determined by supply and demand forces working together in the
marketplace, whereby buyers and sellers negotiate a mutually acceptable price for the
asset
4. The intrinsic, or economic, value of an assetโalso called the fair valueโis the
present value of the assetโs expected future cash flows
10. Valuing Bonds
To illustrate the process for valuing a bond, consider a bond issued by Toyota with a maturity date of 2020 and a stated
annual coupon rate of 4.5 percent.2 In 2015, with 5 years left to maturity, investors owning the bonds were requiring a
2.1 percent rate of return. We can calculate the value of the bonds to these investors using the following three-step
valuation procedure:
11. STEP 2 Determine the investorโs required rate of return by evaluating the riskiness of the bondโs future cash flows. A 2.1
percent required rate of return for the bondholders is given.
18. Yield to Maturity
To measure the bondholderโs expected rate of return, rb, we would find the discount rate that equates the
present value of the future cash flows (interest and maturity value) with the current market price of the
bond.6 It is also the rate of return the investor will earn if the bond is held to maturity, thus the name yield to
maturity. So, when referring to bonds, the terms expected rate of return and yield to maturity are often used
interchangeably.
To solve for the expected rate of return for a bond, we would use the following equation:
