Chap010_PPT.pptVIP

Valuation and Rates of Return 10 Chapter Outline Valuation of assets, based on the present value of future cash flows The required rate of return in valuing an asset is based on the risk involved Bond valuation and its determination Stock valuation and its determination Price-earnings ratio Valuation of Financial Assets Helps in evaluating financial commitment a firm needs to make to: Stockholders and bondholders Attract investment Cost of corporate financing (capital) is used in analyzing the feasibility of an investment on an ensuing project Valuation of Financial Assets 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 market’s 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 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 Valuation of Bonds (cont’d) 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 maturity; t = Number corresponding to a period (running from 1 to n); n = Number of periods; Y = Yield to maturity (or required rate of return) Present Value of Interest Payments To determine the present value of a $100 annuity for 20 years