Week 3_Valuation of shares and bonds

# Week 3_Valuation of shares and bonds - Week 3 Valuation of...

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Week 3 Valuation of ares and bonds shares and bonds 1

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ble of contents Table of contents 1. Valuing a company 1.1 Asset side approach 2 Liability side approach 1.2 Liability side approach 2. Characteristics of Debt and Equity 3. Valuation of corporate debt 4. Valuation of shares 4.1 Constant dividend valuation models 4.2 Constant growth dividend valuation models 3 Estimating the growth rate 4.3 Estimating the growth rate, g 4.4 Price to Earnings ratios 2
Valuing a mpany 1. Valuing a company e value of an asset is a function of: The value of an asset is a function of: The cash flows generated by the asset, and The appropriate discount rate (effective Interest rate) applied to these cash flows E.g. 4 year ordinary annuity paying \$100 0 234 1 100 100 100 PV = \$316.99 100 100/(1+ r ) = 90.91 100/(1+ r ) 2 = 82.64 00 1+ 75 13 3 100/(1+ r ) 3 = 75.13 100/(1+ r ) 4 = 68.30

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firm can be al ed b 1. Valuing a company A firm can be valued by : Calculating the present value of the cash flows generated by the firm’s real assets Calculating the present value of the firm’s individual securities (i.e. equity and debt securities) Assets Real nancial Equity Debt ank loans Financial Non- Tangible Bank loans securities PV of Capital = Discounted sum of PV of Assets = Discounted sum of future cash flows of assets future dividend flows + PV of Debt = Discounted sum of = future cash outflows 4
1 Asset side approach 1. Valuing a company 1.1 Asset side approach Shareholders Dividends FIGURE 3.1 Real assets Interest Net cash flow Debtholders Reinvested + Principal Cash flows generated by a firm’s real assets ultimately flow through to the shareholders and debt holders of g the firm as dividends and interest ence the present value of cash flows generated must Hence the present value of cash flows generated must be equal to the value of cash flows received 5

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1. Valuing a company - 1.1 Asset side approach The net cash flows from real assets, after reinvestment costs, are known as free cash flows If the firm is assumed to have an infinite life, the value of the firm is given by: V = F t t (3.2) where: F = free cash flow generated by the company in period t 1 + r ( ) t = 1 t r = required rate of return (i.e. appropriate discount rate for the company) 6
1. Valuing a company 2 Liability side approach 1.2 Liability side approach Alternatively the value of a company can be determined using the following equation: V = D + E (3.1) where: t l f h fl t d b th fi V = the present value of cash flows generated by the firm D = the present value of cash flows generated by debt securities E = the value of cash flows generated by equity securities gy q y 7

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ble of contents Table of contents 1. Valuing a company 1.1 Asset side approach 2 Liability side approach 1.2 Liability side approach 2. Characteristics of Debt and Equity 3. Valuation of corporate debt 4. Valuation of shares 4.1 Constant dividend valuation models 4.2 Constant growth dividend valuation models 4.3 Estimating the growth rate, g 4.4 Price to Earnings ratios 8
2. Characteristics of Debt and Equity

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## This note was uploaded on 03/09/2012 for the course FINC corporate taught by Professor Kim during the Three '11 term at University of Sydney.

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Week 3_Valuation of shares and bonds - Week 3 Valuation of...

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