Present Value, Bond and Share Valuation

Question 1

Time value of money

Answer 1

Money worth more now than in the future, why?

• compensation required to induce people to make consumption sacrifice
• inflation creates a loss in purchasing power
• there is a risk that the final payout will not be made

Question 2

Present Value

Answer 2

Value today of future cash flow

Question 3

Future Value (FV)

Answer 3

Value of investment over many periods

Question 4

FVn = Vo x (1+r)^n

Answer 4

Vo = cash flow at date 0
r = appropriate interest rate
n = no. of periods over which cash is invested

Question 5

Process of finding FVs is called….?

Answer 5

Compounding

earning interest on top of interest

Question 6

Present Values

Answer 6

PVo = FVn/(1+r)^n
(discount rate r)
Process of finding PVs from future cash flows is called discounting

Question 7

Annuities

Answer 7

An annuity is an investment paying a fixed sum each year for a specified number of payments

Question 8

Present Value Annuitie (PVA)

Answer 8

C x Annuity factor (r, n)
C = Periodic Cash flow
(r, n) = r is discount rate/interest, n is no. of years

Question 9

Annuity factor (r, n) is?

Answer 9

The present value of £1 at the end of each year for n years at discount rate r. (found in appendix at end of textbooks)

Question 10

Perpetuity

Answer 10

An annuity with an infinite number of cash flows eg. UK consuls
PV of Perpetuity = cash flow/discount rate or C1/r

Question 11

What is a Bond?

Answer 11

Bond = a security/financial instrument that obligates the issuer (borrower) to make specified payments to the bondholder during some time horizon.
Can be corporate/government

Question 12

Present Value of a Bond =

Answer 12

PV = C x Annuity factor(r, n) + F/(1+r)^n
C = coupon payment (the interest rate paid to the bondholder ie. coupon rate face value)
n = Maturity (life of bond)
r= discount rate/yield to maturity
n = no. of periods until bond matures
Coupon rate = Annual interest rate as a %

Question 13

Dividend Valuation Model

Answer 13

How to value common shares: the value is given by the sum of all future discounted dividends
Po = Dn/(1+r)^n

Question 14

What does Dividend mean?

Answer 14

sum of money paid regularly (typically annually) by a company to its shareholders out of profits/reserves

Question 15

Dividend growth model

Answer 15

Assumes dividends grow at a constant % rate of “g” per year and forever
Po = Do(1+g)/r-g = D1/r-g
g = constant growth rate
r = discount rate/shareholder’s required return.
Do = this year’s recently paid dividend
D1 = next year’s recently paid dividend D1 = Do(1+g)