1、5,Corporate Financial Management 3e Emery Finnerty Stowe,Valuing Bonds and Stocks,Learning Objectives,Understand typical features of bonds & stocks. Learn how to obtain information about bonds and stocks. Identify the main factors that affect the value of these securities. Learn how to value these s
2、ecurities. Understand how changes in the underlying factors affect the value of these securities.,Chapter Outline,5.1 Bonds 5.2 Bond Valuation 5.3 Bond Riskiness 5.4 Stock Valuation 5.5 Applying the Dividend Valuation Model 5.6 Obtaining Common Stock Information 5.7 The Price-Earnings Ratio,Focus on
3、 Principles,Incremental Benefits The incremental benefits from owning a financial security are its expected future cash flows. Time Value of Money The value of a financial security is the present value of its expected future cash flows. Risk-Return Trade-Off Value and required return reflect the sec
4、uritys risk,Focus on Principles,Two-Sided Transactions Use the fair price of a financial security to compute its expected return, because the fair price does not favor either side in a transaction. Efficient Capital Markets Estimate the required return for a financial security with its expected retu
5、rn. Options Recognize a call provisions value to the issuer.,5.1 Bonds,Bonds represent loans extended by investors to corporations and/or the government. Bonds are issued by the borrower, and purchased by the lender. The legal contract underlying the loan is called a bond indenture.,Key Features of
6、Bonds,The par (or face or maturity) value is the amount repaid (excluding interest) by the borrower to the lender (bondholder) at the end of the bonds life. The par value for U.S. corporate bonds is $1000. The coupon rate determines the “interest” payments. Total annual amount = coupon rate x par va
7、lue. U.S. corporate bonds pay semi-annually. A bonds maturity is its remaining life, which decreases over time. Original maturity is its maturity when its issued. The firm promises to repay the par value at the end of the bonds life (also called maturity).,Key Features of Bonds,A sinking fund requir
8、es principle repayments (buying bonds) prior to the issues maturity. Convertible bonds can be converted into a prespecified number of shares of stock. Typically, these are shares of the issuers common stock. The call provision allows the issuer to buy the bonds (repay the loan) prior to maturity for
9、 the call price. Calling may not be allowed in the first few years.,5.2 Bond Valuation,The bonds fair value is the present value of the promised future coupon and principal payments. At issue, the coupon rate is set such that the fair value of the bonds is very close to its par value. Later, as mark
10、et conditions change, the fair value may deviate from the par value.,Example of Bond Valuation,Semi-annual coupon payment= coupon rate / 2 x par value= 0.09 / 2 x $1,000 = $45 Number of payments = 12 x 2 = 24 Semiannual required rate of return = 3%,Find the fair value of a bond with a $1,000 par val
11、ue, a remaining life of 12 years, and a coupon rate of 9% per year paid semi-annually. The required return on bonds like this one is currently 6% APR.,Example of Bond Valuation,Bond Value: B0 = PV(coupon payments) + PV(par value),Calculator Equation Review,N=24 i=3 PMT=45 FV=1,000 PV= -1,254.03,Bond
12、 Values and Required Returns,Coupon rate = 9% per year.,N=24 i=3 PMT=45 FV=1,000 PV= -1,254.03,N=24 i=4.5 PMT=45 FV=1,000 PV= -1,000.00,N=24 i=6 PMT=45 FV=1,000 PV= -811.74,Yield To Maturity (YTM),The Yield to Maturity is the APR (Annual Percentage Rate) that equates the bonds market price to the pr
13、esent value of its promised future cash flows.This assumes that promised payments will be made in full and exactly on time.,Calculating a YTM,Find the Yield to Maturity (YTM) of a bond with a $1,000 par value, a remaining life of 12 years, and a coupon rate of 9% per year paid semi-annually. The bon
14、d is currently selling for $1,076.23.,N=24 PV= -1,076.23 PMT=45 FV=1,000,Calculating a YTM,YTM/2 = 4% per 6-monthsYTM = 2i = 8% per year,N=24 PV= -1,076.23 PMT=45 FV=1,000 i= 4.0,Current Yield,Assume the 9% coupon bond in the previous example is selling for $1,076.23. Its current yield is then $90/$
15、1,076.23 = 8.36%The current yield ignores gain (or loss) resulting from the difference between the purchase price and the par value.,A Comparison of Bond Returns,Time Path of a Bonds Value,Time Path of a Bonds Value,Bond value,Market Rate,5.3 Bond Riskiness,The YTM is the bonds promised return. But
16、what if the bond issuer defaults? Another source of risk lies with changing interest rates. As the interest rate rises, the price of a fixed-coupon bond falls.,Interest Rate Risk,How does the value of a bond change as interest rates rise? Bond values are inversely related to interest rates. Changes
17、in bond values as interest rates change is known as interest rate risk. How much interest rate risk does a bond have? It depends on the maturity of the bond.,Interest Rate Risk of a Bond,Bond Values and Call Provisions,Call Provision allows the issuer to pay off the bonds prior to maturity. When bon
18、ds are called by the issuer, they are purchased from the holder at the call price. the bonds are then retired. The Yield-to-Call (YTC) is the bonds expected return up to the call date.,Yield to Call of a Bond,Consider our 9% coupon, 12-year bond, selling for $1,254.03, with a 6% YTM. Suppose the bon
19、d can be called in 5 years for $1,090. Assuming it is called at that time, what rate would you earn?,Yield to Call Calculation,So YTC = 2(2.416) = 4.83% YTC YTM,N=10 PV= -1,254.03 PMT=45 FV=1,090 i=2.416,Zero-Coupon Bonds,A zero-coupon bond does not pay any coupon (periodic) interest.The par value i
20、s paid to the bondholder at maturity.Zero-coupon bonds are also known as pure-discount bonds.,Valuing Zero-Coupon Bonds,The required return on a 12 year zero-coupon bond with a par value of $1,000 is 9% APY. What is the bonds value today?,N=12 i=9 PMT=0 FV=1,000 PV= -355.53,5.4 Stock Valuation,There
21、 are two basic types of stock: common and preferred. Common stock represents the residual ownership interest in a firm. Common stockholders get whatever is left over in the event of a bankruptcy. They are “last in line” to get paid.,Preferred Stock,Claims of preferred stockholders are junior to clai
22、ms of debtholders, but senior to those of common stockholders.Limited voting rights compared to common stock.Preferred stock has a par value and a dividend rate.Failure to pay the dividend does not force the issuing firm into bankruptcy.,Preferred Stock Valuation,Consider a $100 par value share of p
23、referred stock with an 8% dividend rate (paid quarterly), and a 15-year life. The required return is 12% APR. Find the shares fair value today.Value = PV(dividends) + PV(par value),Preferred Stock Valuation,N=60 i=3 PMT=2 FV=100 PV= -72.32,N = 15(4) = 60 i = 12/4 = 3 PMT = Dividend = (.08)100/4 = 2
24、FV=100,Preferred Stock Valuation,What if the stock had been perpetual?Then the value of the stock would be:$66.67 = 2/.03,N=10,000 i=3 PMT=2 FV=100 PV= -66.67,Common Stock,Represents residual ownership of the firm. Common stockholders have important voting rights. The issuer may pay dividends to com
25、mon stockholders. However, it is not required to do so. Moreover, there is no pre-set dividend rate. Future dividends are uncertain. We need a way to forecast future dividends.,The Dividend Discount Model,The fair value depends only on the stocks expected future cash flows, which are dividends and a
26、 future sale price. So what is the value of a stock that absolutely can never pay a dividend? Each subsequent future selling price depends on the expected subsequent dividends. Therefore, a stocks fair value can be expressed in terms of only the stocks expected future dividends.,5.5 Applying the Div
27、idend Valuation Model,Investors look at a firm as a source of growing wealth. Therefore, they are interested in the underlying growth of a firm and the implications of that growth rate for the stocks value.,The Dividend Discount Model,The value of a share of stock is the present value of the expecte
28、d dividends over the holding period plus the expected sale price at the end of the holding period.,The Dividend Discount Model,Constant Growth,Assume dividends are growing at a constant percentage rate of g per year.,Constant Growth,More generally, from any period with constant growth forever after
29、time t:,Common Stock Dividends,Future Dividends depend on:the firms earningsdividend policy Payout Ratio = Dividends / Earnings,Common Stock Valuation,The per share annual dividend on a common stock is expected to be $3.00 one year from today. Stockholders require a 12% rate of return. Find the fair
30、 value of the stock for each of the following cases: Zero Growth: dividends are constant every year. Five-Percent Growth: dividends are growing at a constant rate of 5% per year forever. Super-Normal Growth: dividends will grow at 25% for 3 years and then at 5% per year forever.,1. Zero Growth,With
31、g = 0, the dividends of $3.00 per share form a perpetuity.,N=10,000 i=12 PMT=3 FV=0 PV= -25.00,2. Five-Percent Growth,Recall that D1 = $3.00; r = 12%; and g = 5%,N=10,000 i=7 PMT=3 FV=0 PV= -42.86,Dividends,Present Value of Dividends,PV of Dividends,Important Features of the Constant Growth Model,Th
32、e growth rate in dividends (g) is always less than the required rate of return (r). Otherwise, the firms growth would exceed the economys growth forever, which is not possible. Also, the fair value would be negative or infinity, which makes no sense.The growth rate in dividends is also the capital g
33、ains yield on the stock. The capital gains yield is the rate of price appreciation.,Important Features of the Constant Growth Model,The stocks total return is,3. Super-Normal Growth,Apply the constant-growth formula to find the value of the stock at t-1 = 3,Now add the hypothetical sale price of $83
34、.71 to the $4.69 dividend to get a cash flow at year 3 of $88.40. Finally, value the stock as the PV of 3 cash flows.,3. Super-Normal Growth,Now add the hypothetical sale price to the dividend to get a cash flow at year 3:CF3 = 83.71 + 4.69 = $88.40 Then calculate the PV of 3 cash flows:,3. Super-No
35、rmal Growth Model,N=3 i=12 FV=88.40 PMT=0 PV=-62.92 N=2 i=12 FV=3.75 PMT=0 PV=-2.99 N=1 i=12 FV=3.00 PMT=0 PV=-2.6862.92 + 2.99 + 2.68 = 68.58,Source of Dividend Growth,If the Payout Ratio (POR) is constant, growth in dividends depends on the growth in earnings. The growth in earnings depends on: th
36、e amount of earnings retained (1 - POR), and the return earned on that money, i.g = (1 - POR) i,Example of Dividend Growth,Suppose K-Tels EPS was $5.00 this year, it pays out 60% of its earnings in dividends, and all its investments earn a 12.5% return. What is next years expected dividend, and what
37、 is the dividend growth rate?,This years dividend (D0) is EPS0 (POR) = $5.00(0.60) = $3.00 The firm reinvests 40% (1-POR) of its EPS0 Amount reinvested = $5.00(0.40) = $2.00,Example of Dividend Growth,The firm will earn 12.5% on the reinvested $2.00 next year, in addition to the $5.00 of earnings fr
38、om assets already in place ($40 worth of assets earning 12.5%).EPS1 = $5.00 + $2.00(12.5%) = $5.25D1 = $5.25(0.60) = $3.15Note that both dividends and EPS grow by 5%.g = (1 - POR) i = (1 - 0.60) (12.5%) = 5%,5.6 Obtaining Common Stock Information,Sources of information include on-line sources, such
39、as Yahoo! Finance and Google Finance (go to “more” and then “even more”). Traditional sources include newspapers, such as The Wall Street Journal and stock and bond guides, such as Standard & Poors.,5.7 The Price-Earnings Ratio,Like participants in conversations about football and the weather, many
40、investors will join into a discussion concerning the investment potential of a stock and feel good about their contribution, regardless of any knowledge they might have about the stock. These types always bring up the P-E ratio.,The Price-Earnings Ratio,Conventional wisdom holds that a high P/E is g
41、ood and a low P/E is bad.What is the logic behind this statement?,The Logic of the P/E,Recall that so that,Also note that D1 = (POR)(EPS1) and g = (1 - POR)i,The Logic of the P/E,The bracketed amount is the E/P ratio. Holding r and POR constant, the smaller the E/P ratio, the larger i must be. A sma
42、ller E/P ratio is a larger P/E. Therefore, higher P/E implies higher expected return on the earnings reinvested by the firm.,Some Warnings about the P/E,The logic of the P/E depends on expectations, but the P/E is usually based on historical numbers.Currently reported accounting earnings do not refl
43、ect the actual timing of the earnings.The P/E may be high because recent earnings are low!,Measuring the NPV of Future Investments,the value due to assets already in place. the NPV of future investments expected to be made by the firm.,The fair value of a stock can be thought of as being made up of
44、two components:,Measuring the NPV of Future Investments,Suppose the required return (r) equals the return expected from reinvested income (i).,Solve this for P0,Measuring the NPV of Future Investments,If we view the firms earnings as a perpetuity,is the present value of the equity owned portion of t
45、he firms investments,Measuring the NPV of Future Investments,But suppose i does not equal r? Now P0 is higher or lower than the present value of the firms current operations by the amount that the firm is expected to gain or lose on future investments. P0 can be expressed as the value of the firms c
46、urrent operations plus NPVGO, the present value of the firms growth opportunities.,Measuring the NPV of Future Investments,Suppose i r the firm makes positive NPV investments. P0 will be greater than the present value of the firms current operations (P0). Suppose i r the firm makes negative NPV inve
47、stments. P0 will be less than the present value of the firms current operations (P0).,Measuring the NPV of Future Investments,A firm is expected to earn $4.20 per share next year. This amount represents a good estimate of the firms long-run prospects. Shareholders require a 15% rate of return, and t
48、he stock is currently selling for $30.50. What is the expected NPV (per share) of the firms future investments?,Measuring the NPV of Future Investments,Since the stock is worth $30.50, the NPV of future investments is positive and equals $2.50 per share. The firm is expected to increase value by mak
49、ing good (i.e. positive NPV) investments.,Some Final Comments on Security Valuation,Mathematical models of security valuation rely on estimates of various parameters. The estimated value is only as good as the quality of the input parameters. In an efficient market, the market price is a good estimate of the securitys value.,Summary,This chapter describes the typical features of bonds and stocks and presents valuation models for both.,
