Financial Management - Lecture Ten Q&A 2023 Update

How to value a firm? - ANS-Estimate expected future cash flows Estimate cost of capital (r). International macro - Domestic macro - Industry - Firm. Security analysis includes: - ANS-1) Equity valuation: -One measure to value a company -Uses models such as the dividend discount model (DDM) and price-to-earnings (P/E) model. 2)Financial statement analysis: -Analysis of accounting data. 3)Macroeconomic and industry analysis: -The aggregate economy, including international economy and the firm's position within the industry. -To evaluate the business environment in which the firm operates. Why is stock valuation important? - ANS-Assessing investment opportunities: -If the market is undervaluing a given stock - buying signal -If the market is overvaluing a stock - selling signal What is fundamental analysis? - ANS--If you are a security analyst, in order to determine a proper price for a firm's stock, you must forecast the dividends and earnings that can be expected from the firm. -Fundamental analysis is the analysis of the determinants of value for a firm. -Ultimately, the business success of the firm determines the dividends it can pay shareholders and the price it will command in the stock market. -Fundamental analysts are those analysts who use information concerning the current and prospective profitability of a company to assess its fair market value. Distinguish this from technical analysts in last week's lecture. Why study fundamental analysis? - ANS-Different concerned parties have different purposes of analysing financial statements: -Managers/directors -Investors -Creditors -Debtors -Government -Labour union & employees -Lawyers -External/internal auditors There is a relationship between stock prices and accounting numbers. This relationship is helpful for valuation of equity or assets of a company. Fundamental stock analysis: models of equity valuation - ANS-Estimating the intrinsic value for firm and growth rates and opportunities. Basic types of models: -Balance sheet model -Dividend discount model (DDM) -P/E model Stock valuation models - ANS-Value of a stock is based on the present value of the cash flows received from holding it. Discounted cash flow (DCF) model (Inputs to: cash flows; growth; discount rate). The return from a stock is based on (recall holding period return): -The dividend (Dt) -The price from selling the stock (Pt) Intrinsic value - ANS-The worth of a firm that is justified by the information about its forecasted earnings. Market value - ANS-represents the present value of investors' expectation of a firms future earnings. could be mis-priced under the effect of misinterpretation of information and bubbles. Intrinsic value vs market value - ANS--intrinsic value market value, buy -intrinsic value market value, sell -intrinsic value = market value, hold Dividend discount model: general model - ANS-DDM of stock prices is a formula for the intrinsic value of a firm that is equal to the present value of all expected future dividends into perpetuity. Dividends are forecast into infinity and discounted back at the equity cost of capital. Price earnings - ANS-A PE ratio of 20 would mean that an investor is prepared to pay 20 times the historic earnings to buy the share. PE ratios reflect the potential for future growth compared to historic profits. Companies with high PE's are not necessarily expected to perform really ell, just to perform better than they have in the past. Bonds - ANS-Require the issuer to repay the lender/investor the amount borrowed plus interest oiver a specified period of time. Fixed income - coupon rate; Short (1-2 years), medium (5-12 years) long term (12 years). Euro bonds (international bonds) are issued in a country other than that of the currency of denomination. Bonds that are issued in the US in london are called Euro-dollar bonds. Bonds are traded - ANS-Companies issue bonds in the primary markets to raise capital, but bonds can be brought and sold in the secondary market just like shares. The price you buy the bond at is not the face value. Prices of bonds, with face values of £100, Continues...