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Different Valuation Models

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1) Valuation - zero-coupon bond
A U.S. Government bond has a face amount of $10,000 with 8 years to maturity, yielding 3.5%. What is the current selling price?

2) Valuation - corporate bond
A $1,000 corporate bond with 20 years to maturity pays a coupon of 7% (semi-annual) and the market required rate of return is either a) 6.6% or b) 13%. What is the current selling price for both a) and b)?

3) Valuation - corporate bond
A $1,000 corporate bond with 10 years to maturity pays a coupon of 8% (semi-annual) and the market required rate of return is a) 7.2% or b) 10%. What is the current selling price for a) and b)?

4) Valuation - Constant growth - common stock.
What is the value of a share of common stock that paid $1.60 last year, with a growth rate of 7%, assuming the risk free rate is 4%, the market return is 9% and the beta is 1.4?

5) Valuation - zero-coupon bond
A U.S. Government bond has a face amount of $10,000 with 13 years to maturity, yielding 5.5%. What is the current selling price?

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1) Valuation - zero-coupon bond
Face Value of bond=M=$10000
Number of periods=n=8
The current price of zero coupon bond=M/(1+r)^n=10000/(1+3.5%)^8 =$7594.12

2) Valuation - corporate bond
a) 6.6% market required rate of return
Maturity amount=Face Value=M=$1000
Coupon Amount=C=1000*7%/2=$35
Number of coupon payments=n=20*2=40
Semi annual required rate of return=r=6.6%/2=3.3%
Current price of the bond=C/r*(1-1/(1+r)^n)+M/(1+r)^n

Solution Summary

There are 5 problems related to valuation of zero coupon bonds and coupon paying bonds and constant growth stocks. Solutions to these problems depict the step by step methodology to estimate the current value of zero coupon bond, coupon paying bond and stocks with constant growth. Calculations are carried out with the help of suitable formulas.

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Market Valuation Models

Respond to following statements.
1. Outsourcing is any task, operation, job or process that could be performed by employees within an organization, but is instead contracted to a third party for a significant period of time. In addition, the functions that are performed by the third party can be performed on-site or off-site. Personally, I'm against outsourcing of jobs because I lived through my job being outsourced when I worked at Motorola. As an ex-Motorola shareholder, I questioned the strategy of replacing their best engineers with engineers in India and Penang. The downward spiral soon followed. This strategy was driven by bottom line thinking.

At the same time, I believe outsourcing certain jobs is a strategy that companies need to adopt to stay innovative and competitive. We will outsource parts of old or declining product lines to free up capacity for new and developing projects. This allows us to focus our efforts on newer technologies instead of supporting old technologies that will soon be obsolete. Jobs are not lost to this outsourcing; team members are trained on the new technologies and are part of the new product introduction team.

What would happen if our accounting process wouldn't view labor as a liability?

2. Outsourcing is moving the production of goods or the delivery of services from within the organization to a provider outside the organization. This occurs frequently as companies can utilize other providers to either save more or gain quality and time that can be spent on an organization's core competencies. For example, a beer brewery might outsource its bottling and packaging operations when it is growing and still a small operation to allow them to focus on growing the business and beer blends. Another example or reason for outsourcing is the concept of toll manufacturing, in which a company lacks capacity to produce something that they normally can, so they outsource or use a third party company to run the production, ensuring they can meet customer demand and expectations. I would like to note that as the text mentions and numerous people often confuse them, this concept is separate from offshoring, which is moving these similar processes overseas versus domestic for outsourcing. Based on my prior comments and experience with outsourcing, I agree with the concept of outsourcing as needed to meet consumer demand with an assumption of certain standards of service or quality provided by the third party organization. Another thing to consider when deciding to outsource is the impact on personnel and the true savings or gain from doing so. As business leaders, we need to remember that the bottom line isn't the sole focus or responsibility of a company; laying people off due to outsourcing has an impact on these people and their lives and families, so the decision to do so ought to be thoroughly thought out.

3. The assumptions one has to make when valuing have huge effects on what that value is going to be. This is why there are such huge differences in valuations between different brokerage houses. One of these is the growth rates that people estimate. If you think a company is going to grow a certain amount and I think it is going to grow another amount, we will come up with different values of the same company. Does this become a big issue when trying to value a company?

4. Value of a stock or bond from a very simplistic look is based on the relative value it can provide in relation to market alternatives of similar risk and time duration of investment. I prefer to address value from a very high level such as in my first comment to remind myself the purpose of a valuation analysis and my goals for the exercise. Valuation of a stock is based on all the factors mentioned in the discussion question, with a strong focus on how the organization can perform and weather the forecasted economy and industry movement. How will the company be able to outperform the economy upside and industry movement to remain a strong competitor and provide value? Once we have determined the ability of an organization to perform within an industry, the future cash flows can be predicted and utilized in a TVM based calculation of value. I would support the idea that anyone valuing a stock or bond would be using a TVM based valuation method, whether it is NPV, DCF, IRR, or something else. With that being said, industries typically have better or more accurate analysis results under certain methods due to industry or segment quirks. An example of firm valuation would be looking at Apple in the market of technology companies providing consumer devices. Do you feel that their technology and ability to innovate will keep it relevant and maintain current brand loyalty that it has enjoyed since their inception? Also, do they have the ability to maintain market share and sales levels under varying economic conditions? With some of these and many more questions answered, you can begin to estimate future cash flows or validate those provided by other more knowledgeable analysts. With the cash flows determined, it simply comes down to deciding the valuation method and running the figures through the appropriate model.

5. Valuation of a firm's financial assets can be measured in a variety of ways, including CAPEX, EVA, free-cash flow model and dividend discount model. I prefer the use of intrinsic value and dividend discount model, as these help evaluate the actual value of the asset's for both tangible and intangible value. For example, the intrinsic value of an asset is the value of the asset given a hypothetically complete understanding of the asset's investment characteristics. In addition, the dividend discount model is a method of valuing the price of a stock by using predicted dividends and discounting them back to their present value. Essentially, the dividend discount model allows dividends a way to evaluate what cash flows will be returned to the shareholder. Price earnings are utilized when determining a stock's value while taking the company's earnings growth into account. Finally, the free cash flow method is used to look at a firm's cash flow to see what is available for distribution about all the securities holders of a corporate entity. These forms of equity valuation measure assets, earnings, and monetary values that give insight to a firm's financial operations. After looking at the different options available, I believe the discounted cash flow gives better visibility on a company's value. When you evaluate the data provided from discounted cash flows, you have a concise answer as to what's driving the company's growth. Understanding discount rate, or the rate future cash flows must be discounted to present value, is a key variable in the valuation of the firm. Estimates of growth in future free cash flows, in my opinion, lay a foundation for a firm's opportunities for growth. All of the measures mentioned serve a purpose in their valuation of equity and a firm's financial assets. Each in their own way, observe fluctuations or anomalies that provide better insight into a company's true value.

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