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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
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
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)
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
Present Value of Debt (D) is ...

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