Class notes
Notes
Lecturer notes on Financial Mana calculations, concepts and theories.
[Show more]
Connected book
Book Title:
Author(s):
- Edition:
- ISBN:
- Edition:
Seller
Follow
Content preview
Study Unit 4: ValuationsLearning Outcomes
Outline the concepts applied in the valuation of assets
Value debentures, bonds, and preference shares, using a discounted cash
flow technique
Value ordinary equity using the dividend discount model
Employ the free cash flow model to value the firm and the ordinary equity
of the firm
Apply price multiples such as the price-earnings ratio to value ordinary
shares
Employ the Economic Value Added (EVA) approach to value ordinary equity
Adjust valuations for issues such as lack of marketability, share options and
non-controlling interests
Introduction
The valuation of bonds and preference shares is relatively simple because these
assets or liabilities have fixed income streams. Preference dividends earn a fixed
dividend which is based on the face value of the preference shares, hence it is
easy to predict the future cash flows streams. Ordinary shares on the other hand
are difficult to value because they do not have a fixed dividend, since the
dividend is based on a number of factors such as the overall performance of the
company, liquidity and solvency, state of the economy and the dividend policy of
the directors of the business. There are various ways in which the ordinary
shares can be valued. In this chapter we will focus on two methods of valuing
ordinary shares, namely the dividend discount model and the free cash flow
model.
1|Page
, 4.1 What are the fundamental building blocks of a valuation?
The following are among the myths of valuations:
The valuation is quantitative and therefore correct
The valuation is objective
The valuation has precision
The valuation is valid over an extended time period
Only the answer matters
The valuation of investments is mainly based on the future cash flows that are
expected to be received from the investment. Risk factors are also to be
considered in the valuation of investments. Effectively the valuation of
investments is determined to a larger extent by the following factors:
a. The amount of each future cash flow
b. The timing of such cash flows
c. The riskiness of future cash flows
d. The required rate of return
4.2 The Effect of Risk and Return on Valuations
There is a relationship between risk and return, and depending on the type of
the asset. Some assets have a positive relationship between risk and return,
meaning that the higher the risk the higher the return. Therefore, this means
that there is an impact on the value of the expected future cash flows.
4.3 The Effect of Timing of Cash Flows on the Value of Assets
The timing of cash flows can be such that it can be at the beginning or at the
end of each investment period. This means that the coupon payments or
receipts can occur in advance or in arrears. The timing of the cash flows can
thus have a significant impact on the valuation of bonds and preference shares.
2|Page
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through EFT, credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying this summary from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller mainluxx. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy this summary for R283,00. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
67474 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy summaries for 14 years now