Valuation-and-Rates-of-R课件(PPT 87页)

1、Valuation and Rates of Return10第1页，共87页。Chapter OutlineValuation of assets, based on the present value of future cash flowsThe required rate of return in valuing an asset is based on the risk involvedBond valuation and its determinationStock valuation and its determinationPrice-earnings ratio2第2页，共8

2、7页。Valuation of Financial Assets3第3页，共87页。Valuation ConceptsValuation of a financial asset is based on determining the present value of future cash flowsRequired rate of return (the discount rate)Depends on the markets perceived level of risk associated with the individual securityIt is also competi

3、tively determined among companies seeking financial capitalImplying that investors are willing to accept low return for low risk and vice versaEfficient use of capital in the past results in a lower required rate of return for investors4第4页，共87页。Valuation of BondsA bond provides an annuity stream of

4、 interest payments and a principal payment at maturityCash 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 paymentsDiscounted by the yield to maturity added to the present value of the p

5、rincipal5第5页，共87页。Valuation of Bonds (contd)Assuming interest payments ( ) = $100; principal payments at maturity ( ) = $1,000; yield to maturity (Y) = 10% and total number of periods (n) = 20. Thus, the price of binds ( );Where: = Price of the bond; = Interest payments; = Principal payment at matur

6、ity; t = Number corresponding to a period (running from 1 to n); n = Number of periods; Y = Yield to maturity (or required rate of return)6第6页，共87页。Present Value of Interest PaymentsTo determine the present value of a $100 annuity for 20 years, with a discount rate of 10%We have:7第7页，共87页。Present Va

7、lue of Principal Payment (Par Value) at MaturityPrincipal payment at maturity is used interchangeably with par value or face value of the bondDiscounting $1,000 back to the present at 10%, we have:The current price of the bond, based on the present value of interest payments and the present value of

8、 the principal payment at maturity:Here, the price of the bond is essentially the same as its par, or stated value to be received at maturity of $1,0008第8页，共87页。Relationship Between Bond Prices and YieldsBond prices are inversely related to bond yields (move in opposite directions)As interest rates

9、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 decreaseif the required rate of return decreases, the price of the bond will increasePPT 10-89第9页，共87页。 Bond price and required rate of return(yield to maturity)If the mar

10、ket rate is higher than the coupon rate (the annual interest payment divided by the par value), the bond will sell at discount (below par value)If the market rate is equal to the coupon rate, the bond will sell at par valueIf the market rate is lower than the coupon rate, the bond will sell at premi

11、um ( above par value)10第10页，共87页。Concept of Yield to MaturityThe yield to maturity or the discount rate is the required rate of return required by bondholdersThree factors influence the required rate of return:Required real rate of returnInflation premiumRisk premium11第11页，共87页。Concept of Yield to M

12、aturityReal rate of return:Demanded by the investor against current use of the funds on a non-adjusted basisInflation premium: Compensation towards the negative effect of inflation on the value of a dollarRisk free rate of return compensates for the use of funds and loss due to inflationRisk Premium

13、: Towards special risks of an investment12第12页，共87页。Risk Premium (contd)Business Risk: inability of the firm to retain its competitive position and stability and growthFinancial risk: inability of the firm to meet its debt obligations as and when dueAssuming the risk premium is 3%, an overall requir

14、ed rate of return of 10% can be computed;13第13页，共87页。Increase in Inflation PremiumAssume this goes up from 4 to 6%, with everything else being constantPresent value of interest payments: $100 annuity for 20 years at a discount rate of 12%;14第14页，共87页。Increase in Inflation Premium (contd)Present valu

15、e of principal payment at maturity: Present value of $1,000 after 20 years at a discount rate of 12%;Total present value: Assuming that increase inflation increases required rate of return and decreases the bond price by $150 approximately 15第15页，共87页。Decrease in Inflation PremiumAssuming that the i

16、nflation premium declines:The required rate of return decrease to 8%, where the 20 year bond with a 10% interest rate would now sell for;Present value of interest payments16第16页，共87页。Decrease in Inflation Premium (contd)Present value of principal payment at maturity Total present value17第17页，共87页。Bo

17、nd Price Table18第18页，共87页。Time to MaturityInfluences the impact of a change in yield to maturity on valuationLonger the maturity, the greater the impact of changes in yield19第19页，共87页。Impact of Time to Maturity on Bond Prices20第20页，共87页。Determining Yield to Maturity from the Bond PriceThe yield to m

18、aturity (Y), that will equate the interest payments ( ) and the principal payments ( ) to the price of the bond ( )Assuming that a 15 year bond pays $110 per year (11%) in interest and $1,000 after 15 years in principal repayment Choosing an initial percentage to try as a discount rate, we have:21第2

19、1页，共87页。1,3001,2001,1001,000900800 700Bond Price ($)302515Number of years to maturity* The relationship in the graph is not symmetrical in nature.10% bond, $1,000 par valueAssumes 12% yield to maturity50Assumes 8% yield to maturityPPT 10-10Relationship between time to maturity and bond price*22第22页，

20、共87页。Compute the yield to maturityTrial and error processInterpolation methodA less exact calculation of the yield to maturity Principal -Price of the bond Approximate Yield = Annual interest payment + Number of years to maturity to Maturity . 6 (Price of the bond) +.4( Principal payment) 23第23页，共87

21、页。Semiannual Interest and Bond PricesA 10% interest rate may be paid as $50 twice a year in the case of semiannual paymentsTo make the conversion:Divide the annual interest rate by twoMultiply the number of years by twoDivide the annual yield to maturity by twoAssuming a 10%, $1,000 par value bond h

22、as a maturity of 20 years, the annual yield at 12%:10%/2 = 5% semiannual interest rate; hence 5% X $1,000 = %50 semiannual interest20 X 2 = 40 periods to maturity12%/2 = 6% yield to maturity, expressed on a semiannual basis24第24页，共87页。Semiannual Interest and Bond Prices (contd)At a present value of

23、a $50 annuity for the 40 periods, at discount rate of 6%:Present value of interest paymentsPresent value of principal payment at maturityTotal present value25第25页，共87页。Valuation of Preferred StockPreferred stock:usually represents a perpetuity (something with no maturity date)has a fixed dividend pa

24、ymentis valued without any principal payment since it has no ending lifeis considered a hybrid securityowners have a higher priority of claim than common shareholdersprice is based upon PV of future dividendsPPT 10-1226第26页，共87页。Valuation of Preferred Stock27第27页，共87页。Determining the Rate of Return

25、(Yield) from the Market PriceAssuming the annual preferred dividend ( ) is $10 and the price of the preferred stock ( ) is $100, the required rate of return (yield):A higher market price provides quite a decline in the yield: 28第28页，共87页。Valuation of Common StockThe value of common stock is the pres

26、ent value of a stream of future dividendsCommon stock dividends can vary, unlike preferred stock dividendsThere are 3 possible cases:No growth in dividends (valued like preferred stock)Constant growth in dividendsVariable growth in dividendsRequired rate of return reflects the dividend yield on the

27、stock and the expected growth rate in the dividendPPT 10-1329第29页，共87页。Valuation of Common StockGeneral formula No growth in dividends Constant growth in dividends30第30页，共87页。Valuation of a Supernormal Growth FirmPPT 10-1831第31页，共87页。Stock valuation under supernormal growth32第32页，共87页。Determining th

28、e Required Rate of Return from the Market PriceDetermining the required rate of return, knowing the first years dividend, the stock price, and the growth rate (g):Assuming; = Required rate of return (to be solved) = Dividend at the end of the first year, $2.00 = Price of the stock today, $40 g = Con

29、stant growth rate 7%, we have: = $2.00 + 7% = 5% + 7% = 12% $4033第33页，共87页。Valuation Using the Price-Earnings Ratio The Price-Earnings (P/E) ratio can also be used to value common stocksThe P/E ratio is influenced by many factors:the earnings and sales growth of the firmthe risk (or volatility in pe

30、rformance)the debt-equity structurethe dividend policythe quality of managementa number of other factorsPPT 10-1434第34页，共87页。High vs. Low P/EsA stock with a high P/E ratio:indicates positive expectations for the future of the companymeans the stock is more expensive relative to earningstypically rep

31、resents a successful and fast-growing companyis called a growth stockA stock with a low P/E ratio:indicates negative expectations for the future of the companymay suggest that the stock is a better value or buyis called a value stockPPT 10-1535第35页，共87页。Cost of Capital11第36页，共87页。Chapter 11 - Outlin

32、eCost of CapitalCost of DebtCost of Preferred StockCost of Common Equity:Common StockRetained EarningsOptimum Capital StructureMarginal Cost of CapitalThe Security of Market LineSummary and ConclusionsPPT 11-237第37页，共87页。Cost of CapitalThe cost of capital represents the overall cost of future financ

33、ing to the firmThe cost of capital is normally the relevant discount rate to use in analyzing an investmentIt represents the minimal acceptable return from the investmentIf your cost of funds is 10%, you must earn at least 10% on your investments to break even!The cost of capital is a weighted avera

34、ge of the various sources of funds in the form of debt and equityWACC = Weighted Average Cost of CapitalPPT 11-338第38页，共87页。Steps in measuring a firms cost of capital1. Compute the cost of each source of capital.2. Assign weights to each source. Conversion of historical cost of capital structure to

35、market values may be required.3. Compute the weighted average of the component costs.39第39页，共87页。Cost of Capital Baker Corporation40第40页，共87页。Cost of DebtMeasured by interest rate, or yield, paid to bondholdersExample: $1,000 bond paying $100 annual interest 10% yieldCalculation is complex discount

36、rate or premium from par value bondsTo determine the cost of a new debt in the marketplace:The firm will compute the yield on its currently outstanding debt41第41页，共87页。Approximate Yield to Maturity (Y) Annual interest payment + Number of years to maturity 0.6 (Price of the bond) + 0.4 (Principal pay

37、ment)Assuming: Y = $101. 50 + 20 .6 ($940) + .4 ($1,000) = $101.50 + 20 $564 + $400 Y = $101.50 + 3 = $104.50 = 10.84% $964 $964Principal payment Price of the bond$1,000 - $9406042第42页，共87页。Tax and flotation cost consideration Market-determined yields on various financial instruments will equal the

38、cost of those instruments to the firm with adjustment tax and flotation cost consideration43第43页，共87页。Adjusting Yield for Tax ConsiderationsYield to maturity indicates how much the firm has to pay on a before-tax basisInterest payment on a debt is a tax-deductible expenseDue to this, the true cost i

39、s less than the stated cost44第44页，共87页。Adjusting Yield for Tax Considerations (contd)The after-tax cost of debt is calculated as shown below:Assuming:45第45页，共87页。Yield of Preferred StockPreferred stock:has a fixed dividend (similar to debt)has no maturity datedividends are not tax deductible and are

40、 expected to be perpetual or infiniteYield of preferred stock = annual dividend price of stockYield of new preferred stock = annual dividend price-flotation costsFlotation costs: selling and distribution costs (such as sales commissions) for the new securitiesPPT 11-646第46页，共87页。Cost of Preferred St

41、ock (contd)The cost of preferred stock is as follows:Where, = Cost of preferred stock; = Annual dividend on preferred stock; = Price of preferred stock; F = Floatation, or selling costAssuming annual dividend as $10.50, preferred stock is $100, and flotation, or selling cost is $4. Effective cost is

42、: = $10.50 = $10.50 = 10.94% $100 - $4 $9647第47页，共87页。Cost of Common Equity Valuation ApproachIn determining the cost of common stock, the firm must be sensitive to pricing and performance demands of current and future stockholdersDividend valuation model:Where, = Price of the stock today; = Dividen

43、d at the end of the year (or period); = Required rate of return; g = Constant growth rate in dividendsAssuming = $2; = $40 and g = 7%, equals 12 percent = $2 + 7% = 5% + 7% = 12% $4048第48页，共87页。Alternate Calculation of the Required Return on Common StockCapital asset pricing model (CAPM)Where: = Req

44、uired return on common stock; = Risk-free rate of return, usually the current rate on Treasury bill securities; = Beta coefficient (measures the historical volatility of an individual stocks return relative to a stock market index; = return in the market as measured by an approximate indexAssuming =

45、 5.5%, = 12%, = 1.0, would be: = 5.5% + 1.0 (12% - 5.5%) = 5.5% + 1.0 (6.5%) = 5.5% + 6.5% = 12% 49第49页，共87页。Cost of Retained EarningsSources of capital for common stock equity: Purchaser of the new shares external sourceRetained earnings internal sourceRepresent the present and past earnings of the

46、 firm minus previously distributed dividendsBelong to the current stockholders may be paid in the form of dividends or reinvested in the firmReinvestments represent a source of equity capital supplied by the current stockholdersAn opportunity cost is involved50第50页，共87页。Cost of Retained Earnings (co

47、ntd)The cost of retained earnings is equivalent to the rate of return on the firms common cost representing the opportunity cost represents both the required rate of return on common stock, and the cost of equity in the form of retained earningsFor ease of reference, = Cost of common equity in the f

48、orm of retained earnings = Dividend at the end of the first year, $2 = Price of stock today, $40 g = Constant growth rate in dividends, 7% = $2 + 7% = 5% + 7% = 12% $4051第51页，共87页。Cost of New Common StockA slightly higher return than , representing the required rate of return of present stockholders

49、, is expectedNeeded to cover the distribution costs of the new securities Common stock New common stock52第52页，共87页。Cost of New Common Stock (contd)Assuming = $2, = $40, F (Flotation or selling costs) = $4 and g = 7%; = $2 + 7% $40 - $4 = $2 + 7% $36 = 5.6% + 7% = 12.6%53第53页，共87页。Overview of Common

50、Stock Costs54第54页，共87页。Optimum Capital StructureThe optimum (best) situation is associated with the minimum overall cost of capital:Optimum capital structure means the lowest WACCUsually occurs with 40-70% debt in a firms capital structureWACC is also referred to as the required rate of return or th

51、e discount rateBased upon the market value rather than the book value of the firms debt and equityPPT 11-855第55页，共87页。Optimal Capital Structure Weighting Costs (contd)Assessment of different plans (next slide):Firm is able to initially reduce weighted average cost of capital with debt financingBeyon

52、d Plan B, continued use of debt becomes unattractive and greatly increases costs of sources of financing56第56页，共87页。Optimal Capital Structure Weighting Costs (contd) Cost (After-tax) Weights Weighted CostFinancial Plan A:Debt 6.5% 20% 1.3%Equity. 12.0 80 9.6 10.9%Financial Plan B:Debt 7.0% 40% 2.8%E

53、quity. 12.5 60 7.5 10.3%Financial Plan C:Debt 9.0% 60% 5.4%Equity. 15.0 40 6.0 11.4%57第57页，共87页。Cost of Capital Curve58第58页，共87页。Debt as a Percentage of Total Assets (2006)59第59页，共87页。Capital acquisition and investment decision makingThe discount rate used in evaluating capital projects should be th

54、e weighted average cost of capital.If the cost of capital is earned on all projects, the residual claimants of the earnings stream, the owners, will receive their required rate of return. If the overall return of the firm is less than the cost of capital, the owners will receive less than their desi

55、red rate of return because providers of debt capital must be paid.For most firms, the cost of capital is fairly constant within a reasonable range of debt-equity mixes. Changes in money and capital market conditions (supply and demand for money), however, cause the cost of capital for all firms to v

56、ary upward and downward over time.60第60页，共87页。Cost of capital over timeCost of capital (Ka)xyDebt-equity mix (percent)KatKat + 1Kat + 261第61页，共87页。Investment Projects Available to the Baker Corporation62第62页，共87页。Cost of capital and investment projects for the Baker Corporation16.014.012.010.08.06.0

57、4.0 2.00.0Percent10 15 195039Amount of capital ($ millions)10.41%70 8595Weighted average cost of capitalKaABCDEFGH-63第63页，共87页。The Marginal Cost of CapitalThe market may demand a higher cost of capital for each amount of fund required if a large amount of financing is requiredEquity (ownership) capi

58、tal is represented by retained earningsRetained earnings cannot grow indefinitely as the firms capital needs to expandRetained earnings is limited to the amount of past and present earnings that can be redeployed into investments64第64页，共87页。The Marginal Cost of Capital (contd)Assumptions:60% is the

59、amount of equity capital a firm must maintain to keep a balance between fixed income securities and ownership interestBaker Corporation has $23.40 million of retained earning available for investmentThere is adequate retained earning to support the capital structure as shown below:Assuming: X = Reta

60、ined earnings ; Percent of retained earnings in the capital structureWhere X represents the size of the capital structure that retained earnings will support X = $23.40 million = $39 million .60 65第65页，共87页。Costs of Capital for Different Amounts of Financing66第66页，共87页。Increasing Marginal Cost of Ca