Valuation of Long Term SecuritiesValuation of Long Term Securities

Joint MBA ShanghaiWeek 5- 2015

邦保罗邦保罗

What has Mickey Mouse got to do with this?

• In february 2004 Comcast put a hostile take over bid on In february 2004 Comcast put a hostile take over bid on DisneyDisney

• Comcast offered about $ 54 billion for DisneyComcast offered about $ 54 billion for Disney• Many professionals said the bid was far too low and Many professionals said the bid was far too low and

therefore could not be successfultherefore could not be successful• Comcast claimed it offered a 10% premium for the Comcast claimed it offered a 10% premium for the

shareholdersshareholders• But since it was a share for share deal Comcast paid for it But since it was a share for share deal Comcast paid for it

with its own shareswith its own shares• After the bid Disney shares raised 10% and Comcast After the bid Disney shares raised 10% and Comcast

shares fell about 10% at that time the premium evaporated shares fell about 10% at that time the premium evaporated and Comcast actually offered a price for Disney at a and Comcast actually offered a price for Disney at a discount…discount…

• The deal did not effectuate as you imagineThe deal did not effectuate as you imagine• The board of Disney refused to accept it and the The board of Disney refused to accept it and the

shareholders of course also refused…shareholders of course also refused…• In the meantime a fight at the top was taking place In the meantime a fight at the top was taking place

between the cousin of Walt Disney and the CEO Michael between the cousin of Walt Disney and the CEO Michael Eisner…(see the picture)Eisner…(see the picture)

• Eisner won then but had agreed to leave Disney per 2006 Eisner won then but had agreed to leave Disney per 2006 for early retirement…goodbye Mr. Eisner…who saved for early retirement…goodbye Mr. Eisner…who saved Disney when it was about to go bankrupt…Disney when it was about to go bankrupt…

Bye bye Mr. Eisner…Bye bye Mr. Eisner…

Look at the valueline doc.

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

And has Disney bonds outstanding?

Type Issue Price Coupon(%) YTM(%)

Current

Rating CallableYield(%)

Corp DISNEY WALT CO

105.99 6.75 30-Mar-06 2.602 6.369 BBB No

Corp DISNEY WALT CO MTNS BE

104.7 5.5 29-Dec-06 3.29 5.253 BBB No

Corp DISNEY WALT CO MTNS BE

105.39 5.375 01-Jun-07 3.235 5.1 BBB No

Corp DISNEY WALT CO MTNS BE

111.16 6.375 01-Mar-12 4.579 5.735 BBB No

Corp DISNEY WALT CO MTNS BE

110 6.2 20-Jun-14 4.893 5.637 BBB No

Corp

DISNEY WALT CO MTNS BE 113.98 7 01-Mar-32 5.958 6.141 BBB No

Maturity

Valuation

• Liquidation value: Sell as separated Liquidation value: Sell as separated asset from ongoing operations (low) asset from ongoing operations (low) for instance when a company is for instance when a company is bankruptbankrupt

• Book Value: Shareholders equity in Book Value: Shareholders equity in the balance sheet of a companythe balance sheet of a company

• Market Value: Share Price * number Market Value: Share Price * number of (common) shares outstandingof (common) shares outstanding

• Intrinsic Value: Long Term Free Intrinsic Value: Long Term Free Cash Flow/Cost of CapitalCash Flow/Cost of Capital

Valuation of Bonds• A Bond is a confession of debt paper A Bond is a confession of debt paper

from the government or a companyfrom the government or a company

• Each Bond has :Each Bond has :– A face value (say $ 1,000)A face value (say $ 1,000)– A Coupon rate (say 10% per year)A Coupon rate (say 10% per year)– A maturity ( for example 9 years)A maturity ( for example 9 years)– A cost of capital (return that the investor A cost of capital (return that the investor

wants for this specific paper (say 12%) wants for this specific paper (say 12%) This is called the cost of debt (Kd)This is called the cost of debt (Kd)

• Calculating the value of a bond means Calculating the value of a bond means calculating the cash flows that the bond calculating the cash flows that the bond will generate over its life and will generate over its life and discounting at 12%discounting at 12%

Put a value on mickey?

So the value is:• V=$100/(1+12%)+$100/(1+12%)^2+… V=$100/(1+12%)+$100/(1+12%)^2+…

+$100/(1+12%)^9+$1000/(1+12%)^9= +$100/(1+12%)^9+$1000/(1+12%)^9= $ 893,80$ 893,80

• So an investor should pay not more then $ 893,80 to buy So an investor should pay not more then $ 893,80 to buy this bondthis bond

• The bond is sold at a discount (lower then its face value The bond is sold at a discount (lower then its face value of $ 1000)of $ 1000)

• Note that all the coupons are discounted at 12% and at Note that all the coupons are discounted at 12% and at the end of the life time the amount of the the end of the life time the amount of the ““debtdebt”” ($ 1000) ($ 1000) will be paid backwill be paid back

Thanks!

But if Kd= 8% instead of 12%

• V=$100/(1+8%)+$100/V=$100/(1+8%)+$100/(1+8%)^2+… (1+8%)^2+… +$100/(1+8%)^9+$1000/(1+8+$100/(1+8%)^9+$1000/(1+8%)^9= $ 1124,79%)^9= $ 1124,79

• The bond is sold at a The bond is sold at a premium: So now the bond premium: So now the bond has a value higher then its has a value higher then its face value…face value…

Donald’s Uncle

“When will this bond sell at face value (at par)?”

• If the coupon rate offered by the If the coupon rate offered by the issuer of the bond (10%) is issuer of the bond (10%) is equal to the return (Kd) the equal to the return (Kd) the investor demands; so if Kd=10%investor demands; so if Kd=10%

• The return offered (coupon rate) The return offered (coupon rate) is equal to the required Kd so the is equal to the required Kd so the investor is willing to pay the full investor is willing to pay the full amount of $ 1000 amount of $ 1000

• Check it out!Check it out!

Perpetual bonds• Perpetual means that they Perpetual means that they

will give coupon income will give coupon income forever…forever…

• If the coupon is 10% and If the coupon is 10% and Kd=12%Kd=12%

• The value of such a bond The value of such a bond is:V= I/Kd with I=the amount is:V= I/Kd with I=the amount of the couponof the coupon

• Value= $100/12%= $ 833,33Value= $100/12%= $ 833,33

Investor: Have lunch or be lunch!

Zero coupon bond• Some bonds do not pay a couponSome bonds do not pay a coupon• They simply mature after several They simply mature after several

yearsyears• What is the value of such a bond?What is the value of such a bond?• Say Kd=12% and maturity is 10 yrs.Say Kd=12% and maturity is 10 yrs.

• Value= $1000/(1+12%)^10= $ 322Value= $1000/(1+12%)^10= $ 322• You should pay only pay $ 322 for You should pay only pay $ 322 for

such a bondsuch a bondZero Coupon Bond ?

Most bonds issued in the US• Pay coupon interest Pay coupon interest

twice a year (semi twice a year (semi annually) annually) – A 10% bond with half year A 10% bond with half year

coupons and 12 years coupons and 12 years maturity with Kd=14% and maturity with Kd=14% and a face value of $ 1000 can a face value of $ 1000 can be valued at:be valued at:

– V=$50/(1+ 14%/2)^1 V=$50/(1+ 14%/2)^1 +50/(1+14%/2)^2+…..++50/(1+14%/2)^2+…..+……. ……. +$50/(1+14%/2)^24++$50/(1+14%/2)^24+$1000/(1+14%/2)^24= $ $1000/(1+14%/2)^24= $ 770,45770,45

Demo; 2 coupons per year!

Preferred stock valuation• Preferred stock offers preferred Preferred stock offers preferred

dividenddividend• A perpetual stream of fixed A perpetual stream of fixed

dividends will make the valuation dividends will make the valuation look like a perp[etual bond:look like a perp[etual bond:

• Value= Dp (yearly amount of Value= Dp (yearly amount of dividends)/Kp ( the return the dividends)/Kp ( the return the investor wants on this preferred investor wants on this preferred stock)stock)

• So if the dividend is $ 9 per share So if the dividend is $ 9 per share of $1000 and Kp= 14% then of $1000 and Kp= 14% then Value per preferred share= Value per preferred share= Dp/Kp=$9/14%=$ 64,29Dp/Kp=$9/14%=$ 64,29

The most important valuation is the one for common stock

• If a share will be hold forever the If a share will be hold forever the value is the DCF of all future value is the DCF of all future dividendsdividends

• Assumed that the yearly dividends Assumed that the yearly dividends are the same and that Ke= the are the same and that Ke= the return that an investor wants on return that an investor wants on these common shares:these common shares:

• Value per share= Value per share= D1/(1+Ke)+D2/(1+Ke)^2…+Dn/(1+KD1/(1+Ke)+D2/(1+Ke)^2…+Dn/(1+Ke)^ne)^n

• So if D1=D2=D3=…=Dn= $10So if D1=D2=D3=…=Dn= $10• And Ke is 10% Value/share= And Ke is 10% Value/share=

$10/10%=$ 100$10/10%=$ 100

But in reality• Companies pay different Companies pay different

dividends every yeardividends every year• Shareholders hold shares for Shareholders hold shares for

a short time (not forever)a short time (not forever)– In this case value/share is In this case value/share is

(assume the shareholder hold (assume the shareholder hold the shares 2 years :the shares 2 years :

– Value/share=D1/(1+Ke)+D2/Value/share=D1/(1+Ke)+D2/(1+Ke)^2+ P2/(1+Ke)^2 where (1+Ke)^2+ P2/(1+Ke)^2 where P2= the value of the share at P2= the value of the share at the end of the second yearthe end of the second year

Be bullish!

Dividend constant growth• If dividend grows every year by If dividend grows every year by

a certain % then D2=D1(1+g%) a certain % then D2=D1(1+g%) where g% is the growth where g% is the growth percentage and D1=D0(1+g%)percentage and D1=D0(1+g%)

• Now Now value/share=D0(1+g%)/(1+ke%)value/share=D0(1+g%)/(1+ke%)+D0(1+g%)^2/(1+Ke%)^2+…+D0(1+g%)^2/(1+Ke%)^2+…+Dn(1+g%)^n/(1+Ke)^n+Dn(1+g%)^n/(1+Ke)^n

• This can be simplified to: This can be simplified to: • Value/share=D1/(Ke%-g%) Value/share=D1/(Ke%-g%)

proof!proof!• Note: assume Ke%>g% and Note: assume Ke%>g% and

D0(1+g)^n/(1+Ke)^n converges D0(1+g)^n/(1+Ke)^n converges to 0 (nil) for this reasonto 0 (nil) for this reason Bear market?

Homework assignment• Go to Yahoo FinanceGo to Yahoo Finance• Find out if your teamFind out if your team’’s company pays s company pays

dividend and how much per sharedividend and how much per share• What are the earnings per share (latest What are the earnings per share (latest

figures)figures)• What is the pay out ratio (dividends per What is the pay out ratio (dividends per

share/earnings per share) share/earnings per share) • Find out how much dividend the company Find out how much dividend the company

has paid in the past per sharehas paid in the past per share• Find g% (the dividend growth)Find g% (the dividend growth)• Assume that Ke=10%Assume that Ke=10%• Use the dividend growth model to Use the dividend growth model to

calculate the value per share and compare calculate the value per share and compare it with todayit with today’’s share price of your s share price of your companycompany

• Does the share market values your Does the share market values your company shares higher or lower then the company shares higher or lower then the dividend growth model?dividend growth model?

• Why do you think this is the case?Why do you think this is the case?

Rate of Return (yield)• The Yield to Maturity (YTM) for bonds The Yield to Maturity (YTM) for bonds

is:is:

• Say you know todaySay you know today’’s price of a bonds price of a bond• You know also the coupon rate and You know also the coupon rate and

how many times the coupon will pay how many times the coupon will pay per yearper year

• But you would like to calculate at But you would like to calculate at which Kd (yield) the present value of which Kd (yield) the present value of all coupons and the $ 1000 at maturity all coupons and the $ 1000 at maturity will result in todays price; this Kd is will result in todays price; this Kd is the the ““Yield Yield ““

Illustration• A Bond can be bought today A Bond can be bought today

for $ 761for $ 761• The coupon is $80 (8%) per The coupon is $80 (8%) per

yearyear• Maturity is 12 yearsMaturity is 12 years• So we want to find Kd in:So we want to find Kd in:• $761=$80/(1+Kd)^1+$80/$761=$80/(1+Kd)^1+$80/

(1+Kd)^2+…+$80/(1+Kd)^12(1+Kd)^2+…+$80/(1+Kd)^12• We can find it with trial and We can find it with trial and

error or with the IRR% error or with the IRR% function in Excel…(treat $761 function in Excel…(treat $761 as initia; cash out)as initia; cash out)

• Kd=11.828%Kd=11.828%Jump!

Note that

• If interest rates rise If interest rates rise bond prices fallbond prices fall

• If interest rates fall If interest rates fall bond prices increasebond prices increase

• So interest rates and So interest rates and bond prices move in bond prices move in opposite directionsopposite directions

Climb!

End of chapter