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- 1. Valuation of Long Term Securities <ul><li>What is a cynic? A man who knows the price of everything and the value of nothing. </li></ul><ul><li>Oscar Wilde </li></ul>
- 2. Valuation <ul><li>Liquidation value </li></ul><ul><li>Book value </li></ul><ul><li>Market value </li></ul><ul><li>Intrinsic value </li></ul>
- 3. Discounted Cashflow Model <ul><li>The value of an asset is the present value of its expected cashflows discounted at a risk adjusted required rate of return. </li></ul>
- 4. Discounted Cashflow <ul><li>V = C 1 /(1+r) + C 2 /(1+r) 2 + C 3 /(1+r) 3 +….+ </li></ul><ul><li>(C n + M) / (1+r) n </li></ul>
- 5. Required Rate of Return <ul><li>Time </li></ul><ul><li>Inflation </li></ul><ul><li>Risk </li></ul>
- 6. <ul><li>All securities in an equivalent risk class are priced to offer the same expected return. </li></ul>
- 7. Bond Valuation <ul><li>Face value </li></ul><ul><li>Coupon rate </li></ul><ul><li>Maturity </li></ul><ul><li>Future cashflows </li></ul>
- 8. Bond Valuation <ul><li>V = C 1 /(1+r) + C 2 /(1+r) 2 + C 3 /(1+r) 3 +….+ </li></ul><ul><li>(C n + M) / (1+r) n </li></ul><ul><li>Where C 1 …..C n are the coupon payments, M is the maturity value. </li></ul><ul><li>r is the discount rate and V is the value of the bond. </li></ul>
- 9. Bond Valuation <ul><li>V = C* PVIFA r,n + M * PVIF r,n </li></ul><ul><li>Rs 100 FV. 10% coupon. 9 years maturity. </li></ul><ul><li>12% discount rate. </li></ul><ul><li>= 10 * PVIFA (12%.9years) + 100 * PVIF(12%.9years) </li></ul><ul><li>= 10 *5.328 + 100 * 0.361 = 89.38 </li></ul><ul><li>8% discount rate. </li></ul><ul><li>= 10 * PVIFA (8%.9years) + 100 * PVIF(8%.9years) </li></ul><ul><li>= 10* 6.247 + 100 * 0.5 = 112.47 </li></ul>
- 10. Zero Coupon Bond <ul><li>No periodic payment of interest. Sold at discount to face value. </li></ul><ul><li>V = Maturity value * 1/ (1+r) n </li></ul><ul><li> = Maturity value * PVIF r,n </li></ul><ul><li>1000 FV. 10 years. 12% discount rate. </li></ul><ul><li>Value = 1000 * 0.322 = Rs 322 </li></ul>
- 11. Perpetual Bonds <ul><li>A bond that does not mature and hence, pays constant interest forever. </li></ul><ul><li>V = C/ r </li></ul>
- 12. Yield to Maturity <ul><li>The discount rate that equates the present value of all the future cashflows of the bond to the current market price </li></ul><ul><li>Interest rate risk. Relationship between interest rate and bond prices </li></ul>
- 13. Valuation of shares <ul><li>Value of a share equals the present value of expected future dividends. </li></ul><ul><li>Dividend Discount Model </li></ul>
- 14. Valuing Common Stocks <ul><li>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 . </li></ul>
- 15. Valuing Common Stocks <ul><li>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? </li></ul>
- 16. Valuing Common Stocks <ul><li>The formula can be broken into two parts. </li></ul><ul><li>Dividend Yield + Capital Appreciation </li></ul>
- 17. Valuing Common Stocks <ul><li>Price = P 0 =(Div 1 + P 1 )/ (1+r) </li></ul><ul><li>Current price based on forecasted dividend, forecasted price and discount rate </li></ul>
- 18. Valuing Common Stocks <ul><li>Dividend Discount Model - Computation of today’s stock price which states that share value equals the present value of all expected future dividends. </li></ul><ul><li>H - Time horizon for your investment. </li></ul>
- 19. Valuing Common Stocks <ul><li>Example </li></ul><ul><li>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? </li></ul>
- 20. Valuing Common Stocks <ul><li>Example </li></ul><ul><li>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? </li></ul>
- 21. Valuing Common Stocks <ul><li>If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY . </li></ul>
- 22. Valuing Common Stocks <ul><li>If we forecast no growth, and plan to hold out stock indefinitely, we will then value the stock as a PERPETUITY . </li></ul>Assumes all earnings are paid to shareholders.
- 23. Valuing Common Stocks <ul><li>Constant Growth DDM - A version of the dividend growth model in which dividends grow at a constant rate (Gordon Growth Model) . </li></ul>
- 24. Valuing Common Stocks <ul><li>If the same stock is selling for $100 in the stock market, what might the market be assuming about the growth in dividends? </li></ul>Answer The market is assuming the dividend will grow at 9% per year, indefinitely.
- 25. Valuing Common Stocks <ul><li>If a firm elects to pay a lower dividend, and reinvest the funds, the stock price may increase because future dividends may be higher. </li></ul><ul><li>Payout Ratio - Fraction of earnings paid out as dividends </li></ul><ul><li>Plowback Ratio - Fraction of earnings retained by the firm. </li></ul>
- 26. Valuing Common Stocks <ul><li>Growth can be derived from applying the return on equity to the percentage of earnings plowed back into operations. </li></ul><ul><li>g = return on equity X plowback ratio </li></ul>
- 27. Valuing Common Stocks <ul><li>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? </li></ul>
- 28. Valuing Common Stocks <ul><li>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? </li></ul>No Growth With Growth
- 29. Valuing Common Stocks <ul><li>Example - continued </li></ul><ul><li>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. </li></ul><ul><li>The difference between these two numbers (75.00-41.67=33.33) is called the Present Value of Growth Opportunities (PVGO). </li></ul>
- 30. Valuing Common Stocks <ul><li>Present Value of Growth Opportunities (PVGO) - Net present value of a firm’s future investments. </li></ul><ul><li>Sustainable Growth Rate (g) - Steady rate at which a firm can grow: plowback ratio X return on equity. </li></ul>
- 31. Price Earnings Ratio <ul><li>Relationship of growth with P/E ratio </li></ul><ul><li>Shareholder value created thru investments that yield returns in excess of COC </li></ul>
- 32. Growth vs Return <ul><li>ROIC Growth P/E </li></ul><ul><li>Growth Inc 14% 13% 17 </li></ul><ul><li>Returns Inc 35% 5% 17 </li></ul>

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