FINC2011 Lec 4 Valuation of Stocks and Bonds

Question 1

What are 2 ways to find the market value of a firm?

Answer 1

1. PV of all future net “free” cash flows (CFO - investments).
2. PV or all future cash flows to a firms shareholders and debtholders.

1 = 2

Question 2

Debt vs Equity

1. Cashflow
2. Return
3. Life
4. Security (Claim)
5. Redemption
6. Risk / Return

Answer 2

Debt vs Equity

1. Cashflow: Interest vs Dividend
2. Return: Known vs Uncertain
3. Life: Fixed vs Going concern
4. Security (claim): First vs Residual
5. Redemption: Face value vs N/A
6. Risk / Return: Low risk low return vs High risk high return (therefore different required rate of returns).

Question 3

Why do companies care about their bond INVESTMENT GRADE?

Answer 3

Going to have to sell more bonds to raise same money.

Grade down, yield up, PV(bond) / price down.