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Valuation of Long Term Securities (bonds and stocks)

Valuation of Long Term Securities (bonds and stocks). FINC 5000 Week 5- FINC 5000 – FEB 2014. 邦保罗. What has Mickey Mouse got to do with this?. In february 2004 Comcast put a hostile take over bid on Disney Comcast offered about $ 54 billion for Disney

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Valuation of Long Term Securities (bonds and stocks)

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  1. Valuation of Long Term Securities (bonds and stocks) FINC 5000 Week 5- FINC 5000 – FEB 2014 邦保罗

  2. What has Mickey Mouse got to do with this? • In february 2004 Comcast put a hostile take over bid on Disney • Comcast offered about $ 54 billion for Disney • Many professionals said the bid was far too low and therefore could not be successful • Comcast claimed it offered a 10% premium for the shareholders • But since it was a share for share deal Comcast paid for it with its own shares • After the bid Disney shares raised 10% and Comcast shares fell about 10% at that time the premium evaporated and Comcast actually offered a price for Disney at a discount… • The deal did not effectuate as you imagine • The board of Disney refused to accept it and the shareholders of course also refused… • In the meantime a fight at the top was taking place between the cousin of Walt Disney and the CEO Michael Eisner…(see the picture) • Eisner won then but agreed to leave Disney per 2006 for early retirement…goodbye Mr. Eisner…who saved Disney when it was about to go bankrupt… Bye bye Mr. Eisner…

  3. Look at the valueline doc.

  4. And the remainder…(you can enlarge to read or download the doc.)

  5. Disney today…

  6. And has Disney bonds outstanding?

  7. Valuation • Liquidation value: Sell as separated asset from ongoing operations (low) for instance when a company is bankrupt • Book Value: Shareholders equity in the balance sheet of a company • Market Value: Share Price * number of (common) shares outstanding • Intrinsic Value: Long Term Free Cash Flow/Cost of Capital

  8. Valuation of Bonds • A Bond is a confession of debt paper from the government or a company • Each Bond has : • A face value (say $ 1,000) • A Coupon rate (say 10% per year) • A maturity ( for example 9 years) • A cost of capital (return that the investor wants for this specific paper (say 12%) This is called the cost of debt (Kd) • Calculating the value of a bond means calculating the cash flows that the bond will generate over its life and discounting at 12% Put a value on mickey?

  9. So the value is: • V=$100/(1+12%)+$100/(1+12%)^2+… +$100/(1+12%)^9+$1000/(1+12%)^9= $ 893.80 (discount: $ 106.20) • So an investor should pay not more then $ 893.80 to buy this bond • The bond is sold at a discount (lower then its face value of $ 1000) • Note that all the coupons are discounted at 12% and at the end of the life time the amount of the “debt” ($ 1000) will be paid back

  10. But if Kd= 8% instead of 12% • V=$100/(1+8%)+$100/(1+8%)^2+… +$100/(1+8%)^9+$1000/(1+8%)^9= $ 1124.79 (premium $ 124.79) • The bond is sold at a premium: So now the bond has a value higher then its face value…

  11. Perpetual bonds • Perpetual means that they will give coupon income forever… • If the coupon is 10% and Kd=12% • The value of such a bond is:V= I/Kd with I=the amount of the coupon • Value= $100/12%= $ 833,33 • Perpetuity: V= $ Coupon/Kd%

  12. Zero coupon bond • Some bonds do not pay a coupon • They simply mature after several years • What is the value of such a bond? • Say Kd=12% and maturity is 10 yrs. • Value= $1000/(1+12%)^10= $ 322 • You should pay only pay $ 322 for such a bond

  13. Most bonds issued in the US • Pay coupon interest twice a year (semi annually) • A 10% bond with half year coupons and 12 years maturity with Kd=14% and a face value of $ 1000 can be valued at: • V=$50/(1+ 14%/2)^1 +50/(1+14%/2)^2+…..+……. +$50/(1+14%/2)^24+$1000/(1+14%/2)^24= $ 770,45

  14. Note that a bond valuation is… • Vb= C1/(1+i)+ …..+Cn/(1+i)^n+P/(1+i)^n • Vb= Coupon*Annuity (i,n) + Principal/(1+i)^n Annuity(i,n)= (1- 1/(1+i)^n)/I (see the Primer on Time Value of Money) • Thus for 30 year bond with 60 coupon payments of $25 and i=3% per half year: • Vb=$25*(1-1/(1+3%)^60)/3% + $1000/(1.03)^60 • Growing Annuity(i,g,n)= $A*(1+g)*(1-((1+g)^n/(1+i)^n))/(i-g)

  15. Inverse relationship

  16. How to use Excel…

  17. Change in Bond Price as a Function of YTM…interest rate risk for investors in Bonds

  18. We can observe: • Bond prices and yields are inversely related • An increase in a bond’s yield to maturity results in a smaller bond price change than a decrease in yield (of equal magnitude) • Prices of Long Term bonds tend to be more sensitive to interest rate changes than Prices of short term bonds (compare bond A and B) • The sensitivity of bond prices to changes in yields increases at a decreasing rate as maturity increases (compare bond A and B) • Interest rate risk is inversely related to a bond’s coupon rate (low coupon bond prices are more sensitive for interest rate changes)

  19. Preferred stock valuation • Preferred stock offers preferred dividend • A perpetual stream of fixed dividends will make the valuation look like a perpetual bond: • Value= Dp (yearly amount of dividends)/Kp ( the return the investor wants on this preferred stock) • So if the dividend is $ 9 per share of $1000 and Kp= 14% then Value per preferred share= Dp/Kp=$9/14%=$ 64,29 • Note this is a Perpetuity!

  20. The most important valuation is the one for common stock • If a share will be hold forever the value is the DCF of all future dividends • Assumed that the yearly dividends are the same and that Ke= the return that an investor wants on these common shares: • Value per share= D1/(1+Ke)+D2/(1+Ke)^2…+Dn/(1+Ke)^n • So if D1=D2=D3=…=Dn= $10 • And Ke is 10% Value/share= $10/10%=$ 100 • However most likely Di is different …so this becomes a growing Perpetuity

  21. But in reality • Companies pay different dividends every year • Shareholders hold shares for a short time (not forever) • In this case value/share is (assume the shareholder hold the shares 2 years : • Value/share=D1/(1+Ke)+D2/(1+Ke)^2+ P2/(1+Ke)^2 where P2= the value of the share at the end of the second year Be bullish!

  22. Dividend constant growth • If dividend grows every year by a certain % then D2=D1(1+g%) where g% is the growth percentage and D1=D0(1+g%) • Now value/share=D0(1+g%)/(1+ke%)+D0(1+g%)^2/(1+Ke%)^2+…+Dn(1+g%)^n/(1+Ke)^n • This can be simplified to: • Value/share=D1/(Ke%-g%) proof! • Note: assume Ke%>g% and D0(1+g)^n/(1+Ke)^n converges to 0 (nil) for this reason • This is a growing Perpetuity: Bear market?

  23. How to…dividend growth model • Vs(ultimo 2011)= D12/(1+ks)+D13/(1+ks)^2…+D15/(1+ks)^4+P/(1+ks)^4 • If the first 4 dividends/annum are estimated (D12-D15): D(2012)=$$0.32; D(2013)=$0.41; D(2014)=$$0.50 and D(2015)=$ 0.60 • Ks= 11% and growth rate%=9.375%. • Note that : D15/(1+ks)^4+P/(1+ks)4=(D15+P)/(1+ks)^4 • With P= D15(1+g)/(ks-g) • So do not forget to after you calculate P take the present value of P since P is the “Price” of the cash flows after 2015 calculated at the end of 2015…and we calculate value per 1st january 2012…so discount at (1+ks)^4 • The Price in 2015 follows from: P(2015)= D(2015)*(1+g)/(11%-g%) P(2015)= $0.60*(1.09375)/(11%-9.375%)= $40.38 • From the equation under a) it follows: V(2011)= $0.32/1.11+$0.41/(1.11)^2+$0.50/(1.11)^3+$0.60+$40.38(from a)/(1.11)^4= $ 27.98

  24. Assignment Dividend Model • Go to Yahoo Finance • Find out if your team’s company pays dividend and how much per share • What are the earnings per share (latest figures) • What is the pay out ratio (dividends per share/earnings per share) • Find out how much dividend the company has paid in the past per share • Find g% (the dividend growth) • Assume the Cost of equity as dcf • Use the dividend growth model to calculate the value per share and compare it with today’s share price of your company • Does the share market values your company shares higher or lower then the dividend growth model? • Why do you think this is the case?

  25. Earnings Multiplier approach • If b= the retention rate (% of earnings that the company wants to retain i.e. does not want to pay out as dividends) • Then (1-b)= the pay out ratio (% the company will pay out in dividends) • Assume: (1-b)=D1/E1 D1= expected dividend per share of period 1 and E1=expected earnings per share of period 1 • Rewrite: D1=(1-b)*E1 • Then if: Value/share=D1/(Ke%-g%) substitute D1=(1-b)*E1 • And Value/Share V= (1-b)*E1/(Ke%-g%) • And V/E1 (earnings multiplier) or P/E= (1-b)/(Ke%-g%) • Say the retention rate is 40% g%=6% and Ke%=14% and E1=$ 6.67 then the value/share is: V=0.60*$6.67/(14%-6%)= $ 50 • Earnings Multiplier=(1-40%)/(14%-6%)= 7.5 times • Value/share=Expected earnings/share*Earnings Multiplier (PE ration)= $ 6.67*7.5= $ 50 Stock market talk…

  26. Rate of Return (yield) • The Yield to Maturity (YTM) for bonds is: • Say you know today’s price of a bond • You know also the coupon rate and how many times the coupon will pay per year • But you would like to calculate at which Kd (yield) the present value of all coupons and the $ 1000 at maturity will result in todays price; this Kd is the “Yield “

  27. Illustration • A Bond can be bought today for $ 761 • The coupon is $80 (8%) per year • Maturity is 12 years • So we want to find Kd in: • $761=$80/(1+Kd)^1+$80/(1+Kd)^2+…+$80/(1+Kd)^12 • We can find it with trial and error or with the IRR% function in Excel…(treat $761 as initial cash out) • Kd=11.828% Jump!

  28. Assignment: Value Debt • Estimate the Market Value of Debt of your company • Select Debt from the last Balance sheet • Value each component: • Bonds (quotation) • Other debt “intrinsic value” • Refine the WACC% of your company based on your findings Climb!

  29. End of chapter So where are you with your assignments?

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