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Topic Three - Valuation of Stocks and Bonds (1)

Topic Three - Valuation of Stocks and Bonds (1) - Topic 3...

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Topic 3 Valuation of Stocks and Bonds Craig Mellare University of Sydney
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This Lecture What you should know by the end of this lecture Application of financial mathematics How to value a firm How to value debt and equity securities Share valuation models
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Valuation of a Firm Market Value of Firm Two perspectives 1 . Present value of all future net (‘free’) cashflows 2 . Present value of future cashflows to a firms securities (ie. shares + debt) (1) = (2) Why?
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Firm Value = Value of Securities Real assets Debtholders Shareholders Dividends Interest Reinvested Net cash flow + Principal
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Value of A Firm ie. the value of a firms net cashflows F t = net cashflows of firm (less re-investment costs) r = required rate of return (discount rate) for firm V = t=1 00 F t (1+r) t
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Value of a Firm V = D + E where: V = value of cashflows generated by the firm (Net present value of real asset cashflow) D = value of debt used by firm (Net present value of debt cashflows) E = value of equity used by the firm (Net present value of equity cashflows)
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Debt Versus Equity Characteristic Debt Equity Cashflow Interest Dividend Return Fixed Variable Life Fixed Indefinite Security (claim) First Residual Redemption Face value n/a Example Debentures Shares
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Debt Valuation Key Concept value of debt is the present value of future cashflows stemming from the debt Cashflows stemming from debt: Interest (F) = ‘coupon’ which is the dollar amount of interest paid periodically Face value (B) = lump sum paid at end of life of debt security
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Present Value of Debt (D) is ...
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