Financial Assets and Asset Valuation (II)

Question 1

Give reasons why we would want to value assets

Answer 1

• Accounting and auditing purpose
• Redeeming compensation purpose
• Rates and taxation purpose
• Sales and purchases of property
• Securing loans
• Making investment decisions

Question 2

What can create asset valuation uncertainty?

Answer 2

• The acquisition method
• The current replacement cost method
• The depreciation replacement cost method
• The current net realisable value method
• The open market value method
• The book value method

• The present value or capitalisation method Important!

Question 3

How is the price of common stocks determined?

Answer 3

It is the present value of the cash flow (of dividends) received annually.

Question 4

There are two points to consider in common stock valuation
1.
2.

Answer 4

1. Are the earnings and dividends per share are expected to increase with time?
2. What is the uncertainty about expected future dividend payments and stock price?

Question 5

Common stock valuation equation OMP lecture 4 slide 6

Answer 5

Common stock valuation equation OMP lecture 4 slide 6

Question 6

What are the two cash flows for regular bonds?

Answer 6

• Cash flow provided by coupons

* Cash flow provided by repayment of bond par value at maturity

Question 7

What are the relationships between k, the price of the bond, V, and the face value, F?

Answer 7

k > coupon rate, then V < F
k = coupon rate, then V = F
k < coupon rate, then V > F

i.e. when k rises the bond prices fall and vice versa

Question 8

Preferred stocks or shares are called “_____” assets.

They are _____ than bonds but _____ than common stocks.

Answer 8

Preferred stocks or shares are called “mezzanine” assets.

They are riskier than bonds but less risky than common stocks.

Question 9

Preferred stocks have

Answer 9

Preferred stocks have no maturity date, and their value is equal to the PV of dividend payment (from the date of purchase to infinity)

Question 10

What is depreciation?

Answer 10

It means that a charge is made to the income statement, to set aside money to make up for capital consumed during the accounting period

Question 11

Why is depreciation important?

Answer 11

Depreciation is important because it reduces the profit, which might have been perceived as available money for distribution elsewhere.

Question 12

What are the available depreciation methods?

Answer 12

• Straight Line Method
• Declining Balance Method
• Capital Recovery Method
• Sinking Fund Method