LECTURE NOTES
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MODULE:
INV3701
ALL NOTES
DATE:
2021
,INV3701 - Equity asset valuation
Chapter 1: Applications and processes
A. Value definitions
i) Introduction
The key question faced by those in the investment field:
WHAT IS THE VALUEOF A PARTICULAR ASSET?
The answer to this question will normally determine the success
investment decision.
We can define VALUATION as the estimation of the value of an a
- based on variables that relate to future investment returns
- by comparing it to similarassets
- based on estimates of its liquidation proceeds (if appropriate)
ii) Definitions
We will now look at different concepts of value:
1. Fair market value and investment value
Fair market value is the price that a willingbuyer and a willings
prepared to exchange assets or liabilities at when neither the b
seller are under any compulsion to buy or to sell. Another assump
fair market value is that both the buyer and the seller have informa
regarding the material aspects of the asset or liability.
Fair market value is also knownas the market price of the s
Example:
The market value of a stock would be the latest price that the s
the stock market. For example Apple Inc’s closing
rd of price
November
on the 2
2015 was $119.40. This is the market price for Apple Inc.
It is important to note that this market value of $119.40 i
Apple share. This excludes the value of Apple Inc’s debt and preference s
,Investment value is value that is attributable to a specific buyer b
buyer’s specific set of circumstances and requirements, e.g. s
benefits to be achieved by purchasing the asset.
2. Intrinsic value
The intrinsic value of an asset is the value of the asset assumin
complete understanding of all the asset’s investment characteristics.
This in practice is not correct since if it were then the i
and the market value of an asset would be the same – which i
EDGE NOTE:
It is interesting to note that the assumption of the efficient m
that the market value and the intrinsic value of an asset should q
approximate each other.
This theory has been disputed by modern theorists who often seek t
mispricing between the market value and the intrinsic value of a
However, they do agree that over time the market value will converg
the intrinsic value.
3. Estimated value
Estimated value is the value that the investment manager estimates t
correct intrinsic value. He will do this by analyzing data as w
valuation models as well as forecasts and other techniques. This e
will seldom equal the real intrinsic value of the asset due to t
valuation process.
The estimated value is the value that the analyst will arrive at a
extensive research work and then performing his valuation.
The more work done the greater and the closer the estimated value w
intrinsic value.
4. Going-concern
A going-concern assumption assumes that the company will continu
in the foreseeable future.
A company that is in financial distress and that may not b
foreseeable future will be valued based on its liquidation value. This value i
the value if the company were to be dissolved and its assets s
6. Orderly liquidation value
Another method of liquidation will be when the assets are sold i
manner and not on a fire-sale basis. In this case the values a
will typically be higher than in a normal liquidation sale. This t
is referred to as an orderly liquidation valuation.
In most cases the value on a going-concern basis will be higher t
based on a liquidation basis.
iii) Asset mispricing
Based on the above we do say that mispricing between the intrins
the market value of an asset can and does occur!
Therefore the job of an active investment manager is to seek o
mispricings and take advantage of them.
Mispricing can therefore be defined as the difference between:
- The intrinsic value of the asset as estimated by the investm
also knownas the estimated value, AND
- The market value of the asset
Example:
Assume that an investor earns a positive return from convergence o
intrinsic value. I.e. A positive return is earnedwhen the market p
(moves towards) the intrinsic value (the real value of the stock).
When would this situation likely occur?
Solution:
This would occur when the expected return is greater than the require
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