Professional Documents
Culture Documents
The Valuation of
Long-Term
Securities
4.1
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
4.2
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The Valuation of
Long-Term Securities
4.3
Bond Valuation
What is Value?
4.4
What is Value?
4.5
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
4.6
Bond Valuation
4.7
Important Terms
Types of Bonds
Valuation of Bonds
Handling Semiannual
Compounding
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
4.8
4.9
V=
I
(1 + kd)1
t=1
(1 + kd)t
V = I / kd
4.10
I
(1 + kd)2
or
+ ... +
I
(1 + kd)
I (PVIFA k
d,
[Reduced Form]
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
kd
= 10%.
10%
= I / kd
[Reduced Form]
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Tricking the
Calculator to Solve
Inputs
1,000,000 10
N
Compute
N:
I/Y:
PV:
PMT:
FV:
4.12
I/Y
PV
80
PMT
FV
800.0
V=
I
(1 + kd)1
t=1
(1 + kd)
V = I (PVIFA k
4.13
I
(1 + kd)2
+ ... +
I + MV
(1 + kd)n
MV
(1 + kd)n
) + MV (PVIF kd, n)
d, n
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
[Table II]
= $754.16 + $57.00
= $811.16.
$811.16
4.14
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
30
10
I/Y
PV
-811.46
80
+$1,000
PMT
FV
(Actual, rounding
error in tables)
V=
4.16
MV
(1 + kd)n
= MV (PVIFk
d, n
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Zero-Coupon
Bond Example
Bond Z has a $1,000 face value and
a 30 year life. The appropriate
discount rate is 10%. What is the
value of the zero-coupon bond?
V
4.17
30
10
I/Y
PV
57.31
PMT
+$1,000
FV
(Actual - rounding
error in tables)
Semiannual Compounding
Most bonds in the US pay interest
twice a year (1/2 of the annual
coupon).
Adjustments needed:
(1) Divide kd by 2
(2) Multiply n by 2
(3) Divide I by 2
4.19
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Semiannual Compounding
A non-zero coupon bond adjusted for
semi-annual compounding.
I
/
2
I
/
2
I
/
2
+
MV
V =(1 + k /2 )1 +(1 + k /2 )2 + ... +
2 n
d
2*n
t=1
I/2
(1 + kd /2 )
(1 + kd/2 ) *
MV
(1 + kd /2 ) 2*n
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Semiannual Coupon
Bond Example
Bond C has a $1,000 face value and provides
an 8% semi-annual coupon for 15 years. The
appropriate discount rate is 10% (annual rate).
What is the value of the coupon bond?
V
[Table II]
= $614.92 + $231.00
4.21
= $845.92
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
30
I/Y
PV
846.28
40
+$1,000
PMT
FV
(Actual, rounding
error in tables)
Semiannual Coupon
Bond Example
Let us use another worksheet on your
calculator to solve this problem. Assume
that Bond C was purchased (settlement
date) on 12-31-2004 and will be redeemed
on 12-31-2019. This is identical to the 15year period we discussed for Bond C.
What is its percent of par? What is the
value of the bond?
4.23
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
2nd
Bond
12.3104 ENTER
8
ENTER
12.3119 ENTER
10
CPT
ENTER
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Semiannual Coupon
Bond Example
4.25
1.
What is its
percent of par?
84.628% of par
(as quoted in
financial papers)
2.
What is the
value of the
bond?
84.628% x $1,000
face value =
$846.28
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
DivP
(1 + kP)
DivP
+ (1 + k
DivP
t=1
(1 + kP)
P)
+ ... +
DivP
(1 + kP)
or DivP(PVIFA k
P,
V = DivP / kP
4.27
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
4.28
= $100 ( 8% ) = $8.00.
$8.00
= 10%.
10%
= DivP / kP = $8.00 / 10%
= $80
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
4.29
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
V=
Div1
(1 + ke)1
Divt
t=1
(1 + ke)t
=
4.31
Div2
(1 + ke)2
+ ... +
Div
(1 + ke)
Equity investors
required return
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Adjusted Dividend
Valuation Model
The basic dividend valuation model
adjusted for the future stock sale.
V=
Div1
(1 + ke)1
n:
Pricen:
4.32
Div2
(1 + ke)2
Divn + Pricen
+ ... +
(1 + k )n
e
Dividend Growth
Pattern Assumptions
The dividend valuation model requires the
forecast of all future dividends. The
following dividend growth rate assumptions
simplify the valuation process.
Constant Growth
No Growth
Growth Phases
4.33
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
D0(1+g) D0(1+g)2
D0(1+g)
V = (1 + k )1 + (1 + k )2 + ... + (1 + k )
D1
=
(ke - g)
4.34
D1:
g:
ke:
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Constant Growth
Model Example
Stock CG has an expected dividend
growth rate of 8%. Each share of stock
just received an annual $3.24 dividend.
The appropriate discount rate is 15%.
What is the value of the common stock?
stock
D1
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
VZG =
=
4.36
D1
(1 + ke)1
D1
ke
D2
(1 + ke)2
+ ... +
(1 + ke)
D1:
ke:
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Zero Growth
Model Example
Stock ZG has an expected growth rate of
0%. Each share of stock just received an
annual $3.24 dividend per share. The
appropriate discount rate is 15%. What is
the value of the common stock?
stock
D1
= $3.24 ( 1 + 0 ) = $3.24
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
V =
t=1
4.38
D0(1 + g1)
(1 + ke)
Dn(1 + g2)t
t=n+1
(1 + ke)t
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
V =
t=1
4.39
D0(1 + g1)t
(1 + ke)t
Dn+1
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
Stock GP has an expected growth
rate of 16% for the first 3 years and
8% thereafter. Each share of stock
just received an annual $3.24
dividend per share. The appropriate
discount rate is 15%. What is the
value of the common stock under
this scenario?
4.40
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
0
D1
D2
D3
D4
D5
D6
Growth of 8% to infinity!
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
0
D1
D2
D3
Growth Phase
#1 plus the infinitely
long Phase #2
D4
D5
D6
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
D
4
V3 =
k-g
0
D4
D5
D6
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
0
D1
D2
D3
New Time
Line
Where
V3
D4
V3 =
k-g
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
Determine the annual dividends.
D0 = $3.24 (this has been paid already)
D1 = D0(1 + g1)1 = $3.24(1.16)1 =$3.76
D2 = D0(1 + g1)2 = $3.24(1.16)2 =$4.36
D3 = D0(1 + g1)3 = $3.24(1.16)3 =$5.06
D4 = D3(1 + g2)1 = $5.06(1.08)1 =$5.46
4.45
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
0
Actual
Values
3
78
Where $78 =
5.46
0.150.08
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
We determine the PV of cash flows.
PV(D1) = D1(PVIF15%, 1) = $3.76 (0.870) = $3.27
PV(D2) = D2(PVIF15%, 2) = $4.36 (0.756) = $3.30
PV(D3) = D3(PVIF15%, 3) = $5.06 (0.658) = $3.33
P3 = $5.46 / (0.15 - 0.08) = $78 [CG Model]
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
Finally, we calculate the intrinsic value by
summing all of cash flow present values.
V = $61.22
3 D0(1 +0.16)t
V=
t
(1
+0.15)
t=1
4.48
D4
(1+0.15)n (0.150.08)
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
4.49
Step 1:
Press CF
Step 2:
Press 2nd
Step 3: For CF0 Press
key
CLR Work keys
0
Enter
keys
Step 4:
Step 5:
Step 6:
Step 7:
3.76
1
4.36
1
Enter
Enter
Enter
Enter
keys
keys
keys
keys
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Step 11:
Press NPV
Step 12:
Press
15 Enter
Step 13:
Press CPT
keys
keys
keys
keys
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Calculating Rates of
Return (or Yields)
Steps to calculate the rate of
return (or Yield).
1. Determine the expected cash flows.
flows
2. Replace the intrinsic value (V) with
the market price (P0).
3. Solve for the market required rate of
return that equates the discounted
cash flows to the market price.
price
4.51
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
P0 =
t=1
I
(1 + kd )t
= I (PVIFA k
MV
+
(1 + kd )n
) + MV (PVIF kd , n)
d,n
kd = YTM
4.52
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
4.54
$1,250 =
$100(PVIFA9%,15) +
$1,000(PVIF9%, 15)
$1,250 =
$100(8.061) +
$1,000(0.275)
$1,250 =
$806.10 + $275.00
$1,081.10
[Rate is too high!]
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
$910.80 + $362.00
= $1,272.80
4.55
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
0.07 $1,273
IRR $1,250
$23
$192
0.09 $1,081
X
0.02
4.56
$23
$192
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
0.07 $1,273
IRR $1,250
$23
$192
0.09 $1,081
X
0.02
4.57
$23
$192
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
0.07 $1273
YTM $1250
$23
$192
0.09 $1081
X = ($23)(0.02)
$192
X = 0.0024
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
YTM Solution
on the Calculator
Inputs
15
N
Compute
N:
I/Y:
PV:
PMT:
FV:
4.59
I/Y
-1,250
100
+$1,000
PV
PMT
FV
Determining Semiannual
Coupon Bond YTM
Determine the Yield-to-Maturity
(YTM) for the semiannual coupon
paying bond with a finite life.
P0 =
2n
t=1
I/2
(1 + kd
+
/2 )
t
= (I/2)(PVIFAk
MV
(1 + kd /2 )2n
) + MV(PVIFkd /2 , 2n)
d /2, 2n
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
YTM Solution
on the Calculator
Inputs
40
N
Compute
N:
I/Y:
PV:
PMT:
FV:
4.62
I/Y
-950
40
+$1,000
PV
PMT
FV
4.2626% = (kd / 2)
Determining Semiannual
Coupon Bond YTM
Determine the Yield-to-Maturity
(YTM) for the semiannual coupon
paying bond with a finite life.
[ (1 + kd / 2)2 ] 1 = YTM
[ (1 + 0.042626)2 ] 1 = 0.0871
or 8.71%
Note: make sure you utilize the calculator
answer in its DECIMAL form.
4.63
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
2nd
Bond
12.3104 ENTER
8
ENTER
12.3124 ENTER
95
CPT
ENTER
= kd
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Determining Semiannual
Coupon Bond YTM
This technique will calculate kd.
You must then substitute it into the
following formula.
[ (1 + kd / 2)2 ] 1 = YTM
[ (1 + 0.0852514/2)2 ] 1 = 0.0871
or 8.71% (same result!)
4.65
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1600
1400
1200
1000
Par
5 Year
600
15 Year
0
0
8
10
12
Coupon Rate
14
16
18
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Bond Price-Yield
Relationship
When interest rates rise,
rise then the
market required rates of return rise
and bond prices will fall.
fall
Assume that the required rate of return on
a 15 year, 10% annual coupon paying bond
rises from 10% to 12%. What happens to
the bond price?
4.68
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1600
1400
1200
1000
Par
5 Year
600
15 Year
0
0
8
10
12
Coupon Rate
14
16
18
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Bond Price-Yield
Relationship (Rising Rates)
The required rate of return on a 15
year, 10% annual coupon paying
bond has risen from 10% to 12%.
Therefore, the bond price has fallen
from $1,000 to $864.
($863.78 on calculator)
4.70
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Bond Price-Yield
Relationship
When interest rates fall,
fall then the
market required rates of return fall
and bond prices will rise.
rise
Assume that the required rate of
return on a 15 year, 10% annual
coupon paying bond falls from 10% to
8%. What happens to the bond price?
4.71
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1600
1400
1200
1000
Par
5 Year
600
15 Year
0
0
10
12
14
16
18
Coupon Rate
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1600
1400
1200
1000
Par
5 Year
600
15 Year
0
0
8
10
12
Coupon Rate
14
16
18
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
4.77
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Common Stock
Yield Example
Assume that the expected dividend
(D1) on each share of common stock
is $3. Each share of common stock
is currently trading at $30 and has an
expected growth rate of 5%. What is
the yield on common stock?
ke = ( $3 / $30 ) + 5%
ke = 10% + 5% = 15%
4.83
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.