Theory of Valuation

Theory of Valuation - Theory of Valuation • • • The...

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Unformatted text preview: Theory of Valuation • • • The value of an asset is the present value of its expected returns To convert this stream of returns to a value for the security, you must discount this stream at your required rate of return This requires estimates of: – The stream of expected returns, and – The required rate of return on the investment 11-1 Theory of Valuation • Stream of Expected Returns – Form of returns • • Cash flows • Dividends • Interest payments • – Earnings Capital gains (increases in value) Time pattern and growth rate of returns • When the returns (Cash flows) occur11-2 Theory of Valuation • Required Rate of Return – – – – Reflect the uncertainty of Return (cash flow) Determined by economy’s risk-free rate of return, plus Expected rate of inflation during the holding period, plus Risk premium determined by the uncertainty of returns on • Business risk; financial risk; liquidity risk; 11-3 exchanger rate risk and country Theory of Valuation • Investment Decision Process: A Comparison of Estimated Values and Market Prices – You have to estimate the intrinsic value of the investment at your required rate of return and then compare this estimated intrinsic value to the prevailing market price – If Estimated Value > Market Price, Buy – If Estimated Value < Market Price,1Don’t Buy 1-4 Valuation of Alternative Investments • Bond valuation • Preferred stock valuation • Common stock valuation – Dividend Discount Models – Present Value of Operating Free Cash Flows – Present Value of Free Cash Flows to Equity 11-5 ...
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Theory of Valuation - Theory of Valuation • • • The...

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