STOCK AND BOND VALUATION Before starting on this assignment, make sure to thoroughly review the required background material
STOCK AND BOND VALUATION
Assignment Overview
Before starting on this assignment, make sure to thoroughly review the required background materials. This assignment will require you to use the various discounted cash flow methods and dividend models to make computations. In addition to knowing the computational steps involved in stock and bond valuation, make sure you also understand the basic concepts.
Submit your answers as a Word document. Make sure to show your work for all quantitative questions, and make sure to fully explain your answers using references to the background readings for any conceptual questions. Questions 1 and 3 will require Excel, so submit an Excel file that shows your computational steps as a separate file in addition to your Word file. Question 4 is purely conceptual, no computations are necessary but make sure to apply and reference concepts from the required readings in your answers to each of the scenarios.
Case Assignment Question
- Suppose you buy a bond that will pay $1000 in ten years along with an annual coupon payment of $50 and the interest rate is 4%. Answer the following questions:
- What is the value of this bond?
- Now suppose the bond has no coupon payments (it is a “zero coupon” bond) but still pays $1000 in ten years. What is the value of this bond?
- What would happen to the value of the bond if the inflation rate unexpectedly goes up? What the bond value increase or decrease?
- Now suppose the bond still pays an annual coupon of $50 but the interest rate drops to 2%. What is the new value of this bond?
- The XYZ Corporation pays a dividend of $1 for each share and its required rate of return is 8%. Answer the following questions:
- Assuming zero growth in dividends, what is the value of each share?
- Now assume a 4% annual growth rate in the dividend paid. What is the value of each share?
- Assume the growth rate is still 4%, but the required rate of return drops to 6%. What is the new value of each share?
- Acme Medical Corp. is expecting the cash flows from 2018-2022 in the table below. After 2022 it is expecting growth in cash flow at an annual rate of 3%. The firm has determined that its weighted average cost of capital (discount rate) is 7%. Using the table below calculate the following:
- What is the present value of Acme’s future cash flows using the discounted cash flow model?
- If the firm has 200,000 common shares outstanding, zero preferred shares, and debt with a market value of $10,000,000 what would be the value of each share?
- Now suppose the discount rate increases to 10%. How would your answers to a) and b) above change based on the new discount rate?
Year
Cash flow
2018
500,000
2019
550,000
2020
620,000
2021
700,000
2022
800,000
- Suppose the Alpha Manufacturing Corporation is experiencing extreme financial difficulties and is considering bankruptcy. Its shareholders are currently almost equally divided about whether or not the company should go bankrupt, with one outspoken faction pushing for bankruptcy and the other strongly opposing it. They have $50 million in debt all in the form of bonds, and bondholders are pretty well united in that they want the firm to declare bankruptcy.
Assignment Expectations
- Answer the assignment questions directly.
- Stay focused on the precise assignment questions. Do not go off on tangents or devote a lot of space to summarizing general background materials.
- For computational problems, make sure to show your work and explain your steps.
- For short answer/short essay questions, make sure to reference your sources of information with both a bibliography and in-text citations. See attached the Student Guide to Writing a High-Quality Academic Paper, including pages 11-14 on in-text citations.
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Module 2 – Home
STOCK AND BOND VALUATION
Modular Learning Outcomes
· Case
· Identify and explain the distinction between stocks and bonds.
· Apply discounted cash flow models to value stocks.
· Apply discounted cash flow models to value bonds.
· SLP
· Apply P/E ratios to assess and value stock investments.
· Apply the concept of liquidation value for stock investments.
· Evaluate the investment potential of a given company.
· Discussion
· Evaluate the investment potential of a given company.
Module Overview
What exactly are you buying when you purchase stock in a company? There are really two main benefits of owning shares in a company.
The first is that when a company is profitable, it pays dividends to investors. A share in a company is a share in profits. The simplest way to estimate the value of a stock is by how much dividends it pays. We will be using the tools of present value that you learned in Module 1, and apply them to estimating the present value of future dividends to be paid by a company. Specific tools include the zero growth dividend valuation method and the dividend growth model.
The second benefit is that shares in a company typically come with voting rights and a say in how management runs the company. You have probably heard the term “hostile takeover.” This refers to investors purchasing shares of a company in order to gain control of the company and oust the existing management team. Purchase enough shares of a company and get some existing shareholders to take your side and you can gain 51% of the company and vote to oust management.
Another way corporations raise money is by selling bonds. Bonds are different from stocks in that they don’t come with voting rights. However, bonds pay a set amount every year and also come with the promise that your investment will eventually be returned in the future. While bonds don’t come with voting rights or any say in management, if the company is unable to make its payments on your bonds or pay you back, then bondholders can force the company into bankruptcy. In bankruptcy, the assets of the company are sold and given to bondholders. While stock shares give voting rights, bondholders get preference when a company goes into bankruptcy. Shareholders are paid only after bondholders are paid. If there is no money left to pay shareholders, then shareholders get nothing. Overall, stocks are riskier than bonds, but on average give a higher rate of return. As you have probably guessed, we will also be applying the concept of present value to value bonds in this module.
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Module 2 – Background
Required Reading
Start off with these two tutorials that will give you an overview of the basic methods of valuing stocks and bonds from Subjectmoney:
Subjectmoney. (2013, January 2). How to price/value bonds – formula, annual, semi-annual, market value, accrued interest [Video file]. Retrieved from https://www.youtube.com/watch?v=7zCqoED8MVk
Subjectmoney. (2013, January 3). Dividend discount model (DDM) – constant growth dividend discount model – how to value stocks [Video file]. Retrieved from https://www.youtube.com/watch?v=n76Pz3HOBPo
Now dig much deeper into bond and stock valuation with the following books chapters. They cover not only the computational methods but also provide a general overview of stock and bond markets:
Ross, S., Westerfield, R., & Jordan, B. (2007). Chapter 6: Interest rates and bond valuation. Essentials of Corporate Finance. McGraw Hill. Retrieved from http://novellaqalive2.mhhe.com/sites/dl/free/007000000x/484691/Part4_Chap6.pdf [If this link is down, click Interest Rates and Bond Valuation for an alternative link.]
Gitman, L. (2005). Chapter 7: Stock valuation. Principles of Managerial Finance. Pearson Education. Retrieved from http://wps.aw.com/wps/media/objects/222/227412/ebook/ch07/chapter07.pdf [If the link is down, click Stock Valuation or Managerial Finance for an alternative link.]
Finally, for some examples of valuation calculations in Excel see the following videos:
Moy, M. (2014). Bond valuation in Excel. Retrieved from https://www.youtube.com/watch?v=H-_NP0UxX_U
Girvin, M. (2010). Stock valuation with dividend growth model. ExcellsFun. Retrieved from https://www.youtube.com/watch?v=cbRIhwkGAnQ
Girvin, M. (2010). Stock value based on present value of future dividend cash flows. ExcellsFun. Retrieved from https://www.youtube.com/watch?v=G2VIY5E3I3s&t=163s
Optional Reading
Davis, A. (2016). Bond pricing. Retrieved from https://www.youtube.com/watch?v=-DnARyndirI
Ahmad, A. (n.d.). Bonds part II: Pricing. Coursera. Retrieved from https://www.coursera.org/learn/finance-markets/lecture/EpByC/bonds-part-ii-pricing
Ozoguz, A. (n.d.) Basics of equity valuation. Coursera. Retrieved from https://www.coursera.org/learn/global-financial-markets-instruments/lecture/vHPRN/basics-of-equity-valuation
Gitman, L. (2005). Chapter 6: Interest rates and bond valuation. Principles of Managerial Finance. Pearson Education. Retrieved from http://wps.aw.com/wps/media/objects/222/227412/ebook/ch06/chapter06.pdf [If the link is down click Interest Rates and Bond Valuation or Managerial Finance for an alternative link. For a video PowerPoint version of this chapter, click Interest Rates and Bond Valuation ]
Ross, S., Westerfield, R., & Jordan, B. (2007) Chapter 7: Equity markets and stock valuation. Essentials of Corporate Finance. McGraw Hill. Retrieved from novellaqalive2.mhhe.com/sites/dl/free/007000000x/484691/Chap7_EquityMkts.pdf
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Student Guide to Writing a High-Quality Academic Paper
Follow these guidelines when writing academic papers, including your Trident University Case and SLP assignments.
An effective academic writing style is an essential part of a university education.
Poorly written papers detract from your ability to effectively share your knowledge and ideas with others, including your professors.
This guide will help you prepare high-quality papers that are:
Logically argued
Clearly structured and formatted
Written in a professional, academic style
2
The basic structure of an academic paper includes:
1. Cover page
2. Introduction
3. Body of the paper (which may have subsections)
4. Conclusion
5. Reference page
3
The cover page of an academic paper should include the:
▪ University name
▪ Student’s name
▪ Assignment title
▪ Course number and name
▪ Professor’s name
▪ Date Note: Some professors recommend adding the assignment instructions
(tasks and/or questions) to the bottom of the cover page to help students make sure they have addressed each part of the assignment.
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Trident University
Student’s Name
Module 1 Case Assignment
Course Number: Course Name
Professor’s Name
Date
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In the introduction, provide a brief, clear overview of:
1. Each problem or issue that you will discuss
2. The solution to the problem(s) or your response to the issue(s)
3. How you will prove or demonstrate that your solution or response is correct
Tip: Try writing the body of your paper first. Then come back and write the introduction once you know what your paper is about.
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The body of the paper is where you discuss the solution to the problem(s) or your response to the issue(s) raised in the assignment.
After you have read the materials related to the assignment, begin by creating a quick outline:
What are the main points of your argument? Jot them down.
▪ Depending on the length of the paper, 3–6 main points should be plenty.
▪ If a point is complex, it may have 2 or 3 sub-points. Jot those down as well.
Now arrange those points in a logical sequence.
▪ Which point needs to be made first because it provides a basis for the points that follow?
▪ For example, “Point A leads to point B, which leads to point C, and when A, B, and C are considered together they mean that the solution is point D.”
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Example of the structure of a Case Assignment that requires 4 pages of text (not including the cover page, and not including a reference page for assignments that require one):
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Main Sections Points Sub-points Page # # of Paragraphs
Cover Page
Introduction 1 1 Body of Paper Point A 1 1
" Point B 2 1 " Sub-point 1 2 1 " Sub-point 2 3 1 " Point C 3 1 " Point D 4 2
Conclusion 4 1 Reference Page
In the body of your paper:
Use headings and subheadings to help your reader follow the points and sub-points in your discussion and to better organize sections and subsections.
Give each point and sub-point a short name that tells your reader what that section is about. Use those names for your headings.
Here is a quick “how-to” guide to headings with links to examples and instructions: http://blog.apastyle.org/apastyle/2011/04/how-to-use-five- levels-of-heading-in-an-apa-style-paper.html
Now you are ready to begin writing the body of your paper.
Discuss one point at a time and explain each point clearly.
Discuss one point or sub-point in each paragraph.
As you advance to writing more complex papers (e.g., upper-division undergraduate or master’s-level assignments), it may take 2 or 3 paragraphs to fully develop and support a point.
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In the body of your paper:
Each paragraph should be made up of approximately 3–5 sentences. (Note: A single sentence is not a paragraph. Break long sentences into 2 or 3 shorter ones.)
Each paragraph should include:
The point or focus of that paragraph in the first sentence
Additional sentences in which you explain, elaborate, and support your point (see section on Supporting Your Points that begins on the next slide)
A conclusion/transition to the next point and paragraph
Each point should be supported by citing and referencing the sources that provide the foundation for your solutions and/or responses. How to do this will be discussed on the next slide.
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Supporting Your Points
What makes an academic paper “academic”? How does an academic paper differ from other types of writing—for example, a short story, a blog, a newspaper article, a business letter, or an e-mail message?
In an academic paper:
You must provide support for each idea, statement, or point that you make that is based on someone else’s ideas.
Support is provided through citations and references. (References are discussed beginning on Slide 17.) Citations appear within the paper itself wherever you draw upon another person’s ideas or another source of information. References are listed on a separate page at the end of your paper.
Each citation refers to a specific reference so that your reader can look up the sources of your support and read them for himself or herself.
Citations are short and usually only include the author’s last name and the date of publication of the author’s work, for example, “In a study of K–12 education, Jones (2013) found that…”
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Citation Examples
You can cite at the beginning or ending of a sentence: According to Jones (2007), a reason for poor student performance is large
classroom size.
Student performance decreases as classroom size increases (Jones, 2007).
When multiple sources support your point, cite them together in alphabetical order at the end of the sentence:
Educators agree that large classroom size decreases student performance (Adams, 2005; Jones, 2007; Smith, 2008).
When a source is written by more than one person, give their last names in the
citation at the end of the sentence, like this: (Smith, Adams, & Jones, 2006).
When there is no author and/or no date (e.g., a Web page), see this example: http://www.apastyle.org/learn/faqs/web-page-no-author.aspx
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Do not spell out the titles and publication details of your sources in the body of your paper. Instead, provide a short citation, and add a full reference with the publication details in your reference list. Interested readers can then find the details about the article in your reference list at the end of your paper. Wrong: The first article that will be discussed is called “The Very Separate Worlds of Academic and
Practitioner Periodicals in Human Resource Management” written by Sara Rynes, Tamara Giluk, and Kenneth Brown, which was published in the Academy of Management Journal (2007) Vol 50, No.5, 987-1008. They studied the gap between academic and practitioner knowledge. Note: Do not spell out the title and publication details of your sources in the text.
Right (two different ways): 1. Rynes, Giluk, and Brown (2007) found a gap between academic and practitioner knowledge.
Note: The authors are the subject of the sentence. This is referred to as an “in-text citation” and includes just the authors’ last names and year of publication.
2. A gap was found between academic and practitioner knowledge (Rynes, Giluk, & Brown, 2007). Note: The citation is placed at the end of a sentence in parentheses. This is called a
“parenthetical citation.” In this type of citation, use an ampersand (&) instead of “and.”
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When should you cite a source? When you use your own words in referring to the ideas or concepts of others
When you use the exact words that are written in one of the sources that you read
Using someone else’s exact words is called a “quotation.”
For quotes of less than 40 words, use quotation marks and follow the quote with a parenthetical citation that includes:
▪ The name(s) of the author(s)
▪ The year of publication
▪ The page number the quote was taken from in the original source— for example: “Academic and practitioner periodicals in human resource management are worlds apart” (Rynes, Giluk, & Brown, 2010, p. 992).
Any phrase or quote of 40 or more words should be separated from the text of your report by single spacing and by indenting from the both right and left margin. This is called an “offset quote.”
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Provide Support for Each of Your Points
Scholarly academic work builds on previous knowledge and recognizes the contributions that others have made to knowledge.
Providing a citation for each source of information that you use is necessary for at least four reasons:
To help your reader understand the foundational information that you used to support your points.
To give credit to sources of knowledge and the work of others.
To protect the source. If you make a good point but don’t cite your sources or indicate direct quotes with quotation marks, the reader will attribute it to you by default.
To avoid plagiarism. Incorporating material from outside sources (whether direct quotes or paraphrasing) without proper identification or citation is a form of plagiarism. Never represent the work of another as your own.
Here is an excellent guide to help you understand plagiarism and how to avoid it (students are strongly encouraged to study it carefully):
University Libraries, University of Missouri (n.d.). Plagiarism Tutorial. Retrieved March 1, 2013, at http://lib.usm.edu/legacy/plag/plagiarismtutorial.php
15
In your conclusion: Summarize your argument regarding the solutions/responses
that you discussed in the body of your paper, including the most important points you made and how they relate to your overall conclusion.
Do not discuss or raise new issues in the conclusion.
Limit the conclusion to 1 or 2 paragraphs.
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The reference section, found at the end of the paper, is an alphabetical list of the sources that you used to write your paper.
Center the word “References” at the top of a new page.
Starting on the same page, enter a full reference for each citation in your paper. Provide only one reference for each source no matter how many times you cite it in your paper.
Each reference should include the following information (so readers can find the source):
▪ Author’s last name, first initial, middle initial
▪ Year of publication
▪ Title of the article, book, or Web page
▪ Title of the publication where the article was found (If the article is from a journal or newspaper, include the volume and issue number, and the pages where the article is located.)
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Reference section formats for different types of sources:
Article on a Web page with no date: Author last name, first initial, middle initial (publication date). Title of the article. Retrieved X date from http:// Example (note that the second line of the reference is indented five spaces):
Dvoretsky, D. P. (n.d.). History: Pavlov Institute of Physiology of the Russian Academy of Sciences. Retrieved March 1, 2013, from http://www.infran.ru/history_eng.htm
Online newspaper article: Author name (year, month, day of publication). Article title. Newspaper Title. Retrieved X
date from http:// Example (note that the second line of the reference is indented five spaces):
Hilts, P. J. (1999, February 16). In forecasting their emotions, most people flunk out. The New York Times. Retrieved March 1, 2013, from http://www.nytimes.com
Academic Journal Article: Author name, first initial, middle initial (publication year). Article title. Journal Title, vol.
#(issue #), page numbers where the article was found. Example (note that the second and third lines of the reference are indented five spaces):
Shapiro, D., Kirkman, B., & Courtney, H. (2007). Perceived causes and solutions of the translation problem in management research. Academy of Management Journal, 50(2),
249-266.
Book: Author name (publication year). Book Title. Location: Publisher. Example: Fitzgerald, S. P. (2002). Decision Making. London: Capstone Publishing, Ltd.
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Reference Page Example References
Allen, G. (1998). Motivating Supervision. Retrieved March 1, 2013, from: http://www.businessballs.com/mcgregoryxytheorydiagrm.pdf Chapman, A. (n.d.). Adam’s Equity Theory. Retrieved March 1, 2013, from: http://www.businessballs.com/adamsequitytheory.htm Chapman, A. (n.d.). Herzberg’s Motivation Theory. Retrieved June 1, 2009, from: http://www.businessballs.com/herzberg.htm Dreyfack, R. (2004, May). Personalizing productivity. Supervision, 65(5), 20-22. Shapiro, D., Kirkman, B., & Courtney, H. (2007). Perceived causes and solutions of the translation problem in management research. Academy of Management Journal, 50(2), 249-266. Notes:
“n.d.” = no date. Use this for the date when there is no publication date available. First line of each reference is at the left margin, and each subsequent line in that
same reference is indented 5 spaces (one tab stop). Arrange references alphabetically based on last name of the first author of each
work. 19
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