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Fundamental of Financial Management--Canadian Version
Citation preview
C H
A P
T E
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T E N
Valuation and Rates ofReturn
McGraw-Hill Ryerson McGraw-Hill Ryerson Limited 2000
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
E D I T I O N
F
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McGraw-Hill Ryerson
BlockHirt
Short
PPT 10-1
Figure 10-1 / The relationship between time value of money,required return, cost of financing, and investment decisions
Presentvalue
concepts
Required rates ofreturn by investors
Valuation
Analysis ofprojects based
on cost of financingto the firm
Cost offinancing
to the firm
Chapter 10
Chapter 9 Chapter 11 Chapters 12 and 13
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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(10 Percent Interest Payment, 20 Years to Maturity)
Yield to Maturity Bond Price
2% . . . . . . . . . . . . $2,308.114 . . . . . . . . . . . . 1,815.426 . . . . . . . . . . . . 1,458.80
7 . . . . . . . . . . . . 1,317.828 . . . . . . . . . . . . 1,196.36
9 . . . . . . . . . . . . 1,091.29
10 . . . . . . . . . . . . 1,000.0011 . . . . . . . . . . . . 920.3712 . . . . . . . . . . . . 850.61
13 . . . . . . . . . . . . 789.2614 . . . . . . . . . . . . 735.0716 . . . . . . . . . . . . 644.27
20 . . . . . . . . . . . . 513.0425 . . . . . . . . . . . . 406.92
PPT 10-2
Table 10-1Bond price table
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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0 . . . . . . . . $1,000.00 $1,000.001 . . . . . . . . 1,018.52 982.145 . . . . . . . . 1,079.85 927.90
10 . . . . . . . . 1,134.20 887.0015 . . . . . . . . 1,171.19 863.7820 . . . . . . . . 1,196.36 850.61
25 . . . . . . . . 1,213.50 843.14
30 . . . . . . . . 1,225.16 838.90
Time Period Bond Price with Bond Price within Years 8 Percent Yield 12 Percent Yield
(of 10 percent bond) to Maturity to Maturity
PPT 10-3
Table 10-2Impact of time to maturity on bond prices
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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1,300
1,200
1,100
1,000
900
800
700
Bond Price ($)
30 25 15Number of years to maturity
* The relationship in the graph is not symmetrical in nature.
10% bond, $1,000 par value
Assumes 12% yield to maturity
5 0
Assumes 8% yield to maturity
PPT 10-4
Figure 10-2Relationship between time to maturity and bond price*
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Table 10-3An example of stock quotations from the Globe and Mail
PPT 10-5
Source: ILX Systems, a division of Thomson Information Services Inc.
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Stock valuation under supernormal growth analysis
PPT 10-6
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Chapter 10 - Outline LT 10-1
Valuation Concepts
3 Factors that Influence the Required Rate ofReturn
Valuation of Bonds
Relationship Between Bond Prices and Yields
Preferred Stock
Valuation of Common Stock
Valuation Using the Price-Earnings Ratio
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Valuation concepts
Value or price of a stock or bond is based upon the presentvalue of future cash flows to the investor
Discount rate used is investors required rate of return,based on the markets estimates of risk, efficiency, andexpected future returns
LT 10-2
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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3 Factors that Influence theRequired Rate of Return LT 10-3
Real Rate of Return:
represents the opportunity cost of the investment
in the early 1990s, 5-7%, but now about 3-4%
Inflation Premium:
a premium to compensate for the effects of inflation
lately, 2%
Risk Premium:
a premium associated with business and financial risk
typically, 2-6%
So, the Required Rate of Return equals:
Real Rate of Return + Inflation Premium + RiskPremium
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Valuation of Bonds LT 10-4
The value of a bond is made up of 2 parts:
PV of the interest payments (an annuity)
PV of the principal payment (a lump sum)
The principal payment at maturity:
can also be called the par value or face value
is usually $1,000
The interest rate used:
is the yield to maturity or discount rate
is also the required rate of return
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Relationship BetweenBond Prices and Yields LT 10-5
Bond prices are inversely related to bond yields (move inopposite directions)
As interest rates in the economy change, the price or valueof a bond changes:
if the required rate of return increases, the price of thebond will decrease
if the required rate of return decreases, the price of thebond will increase
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Valuation of Preferred Stock LT 10-6
Preferred stock:
usually represents a perpetuity (something with nomaturity date)
has a fixed dividend payment
is valued without any principal payment since it has noending life
is considered a hybrid security
owners have a higher priority than commonshareholders
price is based upon PV of future dividends
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Valuation of Common Stock LT 10-7
The value of common stock is the present value of a streamof future dividends
Common stock dividends can vary, unlike preferred stockdividends
There are 3 possible cases:
No growth in dividends (valued like preferred stock)
Constant growth in dividends
Variable growth in dividends
Required rate of return reflects the dividend yield on thestock and the expected growth rate in the dividend
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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Valuation Using thePrice-Earnings Ratio LT 10-8
The Price-Earnings (P/E) ratio can also be used to valuecommon stocks
The P/E ratio is influenced by many factors:
the earnings and sales growth of the firm
the risk (or volatility in performance)
the debt-equity structure
the dividend policy
the quality of management
Average P/E ratio for TSE 300 in early 1999 was 27 to 1
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McGraw-Hill Ryerson Limited 2000
Foundations of FinancialManagement CANADIAN
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High vs. Low P/Es LT 10-9
A high P/E ratio:
indicates positive expectations for the future of thecompany
means the stock is more expensive relative to earnings
typically represents a successful and fast-growingcompany
A low P/E ratio:
indicates negative expectations for the future of thecompany
may suggest that the stock is a better value or buy
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