Financial Management: Common Stock Valuation Models Essay

Question:

Describe about the Financial Management for Common Stock Valuation Models.

Answer:

1: Portfolio Valuation

a) Covariance between shares:

Correlation = Covariance of both stock return / (SD of stock 1 * SD of stock 2)

-0.3 = Covariance of both stock return / (18% * 32%)

Covariance of both stock return = -0.3 * (18% * 32%)

Covariance of both stock return = -0.01728

b) Expected return and SD of the portfolio:

Expected return from the portfolio:

Expected return = w1R1 + w2R2

Expected return = (35% * 12%) + (65% * 24%)

Expected return = 4.2% + 15.6%

Expected return = 19.80%

Standard Deviation from the portfolio:

Variance = [(w12R12) + (w12R12) + (2* R1 * R2 *CovR1R2)

Variance = [(((35%)^2)*((18%)^2))+(((65%)^2)*((32%)^2))+(2 * 35% * 65% * -0.01728)]

Variance = 3.94%

Standard Deviation = ?Variance

Standard Deviation = ? 3.94%

Standard Deviation = 19.84%

c) Depicting the weight of portfolio:

Weighted of Jay shares:

Expected return = (R1 – R2) / R2

15.60% = W1 * (12% – 24%) / 24%

W1 = 70%

Weighted of Kay shares:

Expected return = (R2 – R1) / R1

15.60% = W2 * (24% – 12%) / 12%

W1 = 30%

d) Calculating the variance and SD of the portfolio:

Variance = [(w12R12) + (w12R12) + (2* R1 * R2 *CovR1R2)

Variance = [(((70%)^2)*((18%)^2))+(((30%)^2)*((32%)^2))+(2 * 70% * 30% * -0.01728)]

Variance = 1.78%

Standard Deviation = ?Variance

Standard Deviation = ? 1.78%

Standard Deviation = 13.35%

2: Bond Valuation

a) Calculating the Market price of each bond:

Bond

A

B

C

Total Period

5

10

8

Yield Rate

7.50%

7.50%

7.50%

Half Year Coupon Rate

6.50%

Coupon Payment

0

65

55

Coupon Rate p.a.

0%

5.50%

No. of Coupon Payments

0

20

8

Half Yearly Yield Rate

3.75%

3.75%

Face Value

1000

1000

1000

Market Price of Bonds

1000

1382.15

882.85

b) Classifying the bond on premium, par, or discount:

The Face value and market value of Bond A has not changed, which only depicts the bond as At Par. In addition, the Bond B’s market value is higher than its face value, which depicts that the bond classification as At Premium. Furthermore, Bond C’s market value is lower than its face value, which classifies the bond as At Discount.

c) Depicting the number of bond that needs to be issued by Jasmine for raising the capital:

Total number for Bond sales = Total capital requirement / Bond B market price

Total number for Bond sales = $465260 / 1382.15

Total number for Bond sales = 337

In addition, Jasmine needs to sell around 337 of Bond B to attain the capital of $465,260.

3: Share valuation

a) Depicting the current market price of NoChange Ltd with no growth potential:

Zero growth dividend model = Dividend / (Discounting rate)

Zero growth dividend model = $4.25 / 10%

Zero growth dividend model = $42.5

b) Depicting the current market price of ConstantGrowth Ltd with growth potential:

Constant growth dividend model = Future Dividend / (Discounting rate – Growth rate)

Constant growth dividend model = (Current dividend * Growth rate) / (Discounting rate – Growth rate)

Constant growth dividend model = ($4.25 * 4%) / (10% - 4%)

Constant growth dividend model = $73.67

c) Depicting the current market price of SteadyGrowth Ltd:

Steady growth dividend model = Future Dividend / (Discounting rate – Growth rate)

Steady growth dividend model = $4.25 / (10% - 4%)

Steady growth dividend model = $70.83

d) Depicting the current market price of SuperGrwoth Ltd:

The super normal growth for three years

D1 = $4.25 * 1.12 = $4.76

D2 = $4.76 * 1.12 = $5.3312

D3 = $5.3312 * 1.12 = $5.970944

) / (0.10 - 0.04)

P3 = $103.496

After three years, steady growth rate of 4%

P3 = D3 * (1 + g) / (R - g)

P3 = ($5.970944 * 1.04

Present valuation of the share price:

P0 = D1 / (1+R)1 + D2 / (1+R)1/2 + D3 / (1+R) 1/3 + P3 / (1+R) 1/3

P0 = $4.76 / (1.10) + $5.3312 / (1.10) 1/2 + $5.970944 / (1.10) 1/2 + $103.496 / (1.10)3

P0 = 4.3272 + 4.406 + 4.486 + 77.7581

P0 = $90.977

e) Depicting the current market price of QuickGrowth Ltd:

The super normal growth for three years

D1 = 4.25

D2 = $4.25 * 1.12 = $4.76

D3 = $4.76 * 1.12 = $5.3312

D4 = $5.3312 * 1.12 = $5.970944

After three years, steady growth rate of 4%

P4 = D4 * (1 + g) / (R - g)

P4 = ($5.970944 * 1.04) / (0.10 - 0.04)

P4 = $103.496

Present valuation of the share price:

P0 = D1 / (1+R) + D2 / (1+R)1/2 + D3 / (1+R)1/3 + D4 / (1+R)1/4 + P4 / (1+R)1/4

P0 = $4.25 / (1.10) + $4.76 / (.10)1/2 + $5.3312 / (.10) 1/3 + $5.970944 / (.10) 1/4 + $103.496 / (.10) 1/4

P0 = 3.8636 + 3.93388 + 4.0054 + 4.0782 + 70.689

P0 = $86.57033

Conclusion:

The overall report mainly helps in depicting the calculation of bond valuation, portfolio valuation and share price valuation. In addition, the novice with the help of effective formula was able to complete the assignments requirements. Furthermore, the understanding of calculations mainly help in providing the working for different calculations.

Recommendation:

The calculation of bond valuation, portfolio valuation and share price valuation could be effective used by the novice for detecting the prices of a security. In addition, these formulas could be applied in the real world for determining the risk and return, which could be generated from a particular investment.

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