十三 Asset Valuation Equity Investments

十三 Asset Valuation Equity Investments

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十十 Asset Valuation: Equity Investments 1.A: An Introduction to Security Valuation a: Explain the top-down approach and its underlying logic to the security valuation process. Step 1 General economic influences: fiscal policy: tax cuts encourage spending and tax increases discourage spending. monetary policy: a restrictive policy reduces the availability of funds and causes interest rates to rise putting upward pressures on costs. In addition to fiscal and monetary actions you must also consider the economic consequences of political changes around the globe. From a global portfolio perspective you have to consider the economic events in other countries. Step 2 Industry influences: The next step in the valuation process is to identify those industries that will prosper or suffer during the time frame of your economic forecast. You should consider the cyclical nature of the industry under study. Some industries are cyclical, some are contra cyclical and some are non-cyclical. Finally, your analysis should also account for foreign economic shifts. In general, an industry’s prospects within the global business environment determine how well or poorly individual firms in the industry do. Step 3 Company Analysis: After determining the industry’s outlook you should compare the individual firm’s performance within the entire industry using financial ratios and cash flow values. Your goal is to identify the best company in a promising industry. This involves not only examining the firm’s past performance, but also its future prospects. b: Calculate the value of a preferred stock, assuming a perpetual dividend. Valuation of preferred stock is easy since the dividend is fixed and the preferred’s life is infinite (it’s a perpetuity) appears in the upper right hand corner. Again, the only problem is determining k P . Because of default risk factors, the preferred’s discount rate (k P ) should be above the firm’s bond rate (k B ). But since dividends paid by one corporation to another corporation are 80% tax exempt, preferred yields are below the firm’s highest-grade bond yields. preferred value= D + D +...+ D = D (1 +k p ) 1 (1 + k p ) 2 (1 + k p )°° k p Example : value the preferred of a company that pays a $5 annual dividend. The firm’s bonds are currently yielding 8.5% and preferred shares are selling to yield fifty basis points below the firm’s bond yield. Step 1: determine the discount rate. 8.5% - .5% = 8% Step 2: value the preferred. D/k P = $5/.08 = $62.50 c: Calculate the value of a common stock, using the dividend discount model (DDM) for both a one-year holding period and a multiple-year holding period.
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Example: what is the value of a stock that last year paid a $1 dividend, if you think: next year’s dividend will be 10% higher; the stock will be selling for $25 at year end; the risk free rate of interest is 5%, the market return is 10% and the stock’s beta is 1.2? Step 1:
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十三 Asset Valuation Equity Investments

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