Chapter 4
The
The Valuation
Valuation of
of
Long-Term
Long-Term
Securities
Securities
Course Instructor: Dr. Zulfiqar Ali
4.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The Valuation of
Long-Term Securities
• Distinctions Among Valuation
Concepts
• Bond Valuation
• Preferred Stock Valuation
• Common Stock Valuation
• Rates of Return (or Yields)
4.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
• Going-concern value represents the
amount a firm could be sold for as a
continuing operating business.
• Simply put, Going-concern value
represents the potential future benefits a
business can generate.
• Investors analyze going-concern value
when they believe that a company has
the potential to survive and grow in the
4.3 future.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
• Liquidation value
• Investors use liquidation value when
they believe a company has no
usefulness as a going-concern. In
this case, investors want to know
how much money they can receive
from selling off the company’s
assets, which consists of all sales
proceeds less all selling expenses.
4.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
• Book value represents either:
(1) an asset: the accounting value
of an asset – the asset’s cost
minus its accumulated
depreciation;
(2) a firm: total assets minus
liabilities and preferred stock as
listed on the balance sheet.
4.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
• Market value represents the
market price at which an asset
trades.
• Intrinsic value represents the
price a security “ought to have”
based on all factors bearing on
valuation.
4.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
Intrinsic value is an estimate of the
actual true value of a company,
regardless of market value.
There is an inherent degree of difficulty
in arriving at a company's intrinsic value.
4.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
Due to all the possible variables involved,
such as the value of the company's
intangible assets, estimates of the genuine
value of a company can vary greatly between
analysts.
E.g. Some analysts utilize discounted cash flow
analysis to include future earnings in the
calculation, while others look purely at the
current liquidation value or book value as shown
4.8 on the company's most recent balance sheet.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
Market value is the current value of a
company as reflected by the company's
stock price. Therefore, market value
may be significantly higher or lower than
the intrinsic value.
4.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
What is Value?
Market value is also commonly used to
refer to the market capitalization of a
publicly-traded company and is obtained
by multiplying the number of its
outstanding shares by the current share
price.
4.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Bond Valuation
• Important Terms
• Types of Bonds
• Valuation of Bonds
• Handling Semiannual
Compounding
4.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Important Bond Terms
• A bond is a long-term debt
instrument issued by a
corporation or government.
• The maturity value (MV) [or face
value] of a bond is the stated
value. In the case of a US bond,
the face value is usually $1,000.
4.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Important Bond Terms
• The bond’s coupon rate is the stated
rate of interest; the annual interest
payment divided by the bond’s face
value.
• The discount rate is dependent on
the risk of the bond and is composed
of the risk-free rate plus a premium
for risk.
4.13 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Different Types of Bonds
A perpetual bond is a bond that never
matures. It has an infinite life.
I I I
V= (1 + kd)1 + (1 + kd)2 + ... + (1 + kd)¥
¥ I
=S (1 + kd)t or I (PVIFA k )
t=1 d, ¥
V = I / kd [Reduced Form]
4.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Perpetual Bond Example
Bond P has a $1,000 face value and
provides an 8% annual coupon. The
appropriate discount rate is 10%. What is
the value of the perpetual bond?
I = $1,000 ( 8%) = $80.
kd = 10%.
V = I / kd [Reduced Form]
= $80 / 10% = $800.
4.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Different Types of Bonds
A non-zero coupon-paying bond is a
coupon paying bond with a finite life.
I I I + MV
V= (1 + kd)1 + (1 + kd)2 + ... + (1 + kd)n
n I MV
=S (1 + kd) t
+
t=1 (1 + kd)n
V = I (PVIFA k ) + MV (PVIF kd, n)
d, n
4.16 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Coupon Bond Example
Bond C has a $1,000 face value and provides
an 8% annual coupon for 30 years. The
appropriate rate of return is 10%. What is the
value of the coupon bond?
V = $80 (PVIFA10%, 30) + $1,000 (PVIF10%, 30)
= $80 (9.427) + $1,000 (.057)
[Table IV] [Table II]
= $754.16 + $57.00
= $811.16.
4.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Different Types of Bonds
A zero coupon bond is a bond that pays
no interest but sells at a deep discount
from its face value; it provides
compensation to investors in the form
of price appreciation.
MV
V= = MV (PVIFk )
(1 + kd)n d, n
4.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Zero-Coupon
Bond Example
Bond Z has a $1,000 face value and
a 30 year life. The appropriate rate
of return is 10%. What is the value
of the zero-coupon bond?
V = $1,000 (PVIF10%, 30)
= $1,000 (0.057)
= $57.00
4.19 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Semiannual Compounding
Most bonds in the US pay interest
twice a year (1/2 of the annual
coupon).
Adjustments needed:
(1) Divide kd by 2
(2) Multiply n by 2
(3) Divide I by 2
4.20 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Semiannual Compounding
A non-zero coupon bond adjusted for
semi-annual compounding.
I / 2 I / 2 I / 2 + MV
V =(1 + k /2 )1 +(1 + k /2 )2 + ... + 2 n
d d (1 + kd/2 ) *
2*n I/2 MV
=S (1 + kd /2 ) t
+
t=1 (1 + kd /2 ) 2*n
= I/2 (PVIFAkd /2 ,2*n) + MV (PVIFkd /2 ,2*n)
4.21 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Semiannual Coupon
Bond Example
Bond C has a $1,000 face value and provides
an 8% semi-annual coupon for 15 years. The
appropriate discount rate is 10% (annual rate).
What is the value of the coupon bond?
V = $40 (PVIFA5%, 30) + $1,000 (PVIF5%, 30)
= $40 (15.373) + $1,000 (.231)
[Table IV] [Table II]
= $614.92 + $231.00
= $845.92
4.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Semiannual Coupon
Bond Example
Ms. Shakeera wants to invest in a Bond that
has $3,000 face value and provides 10%
quarterly coupon for 8 years. The appropriate
discount rate is 8% (annual rate). What is the
value of the coupon bond?
V = $75 (PVIFA2%, 32) + $3,000 (PVIF2%, 32)
= $75 (23.45) + $3,000 (.531)
= $1,758.75 + $1,593
= $3,351.75
4.23 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Preferred Stock Valuation
Preferred Stock is a type of stock
that promises a (usually) fixed
dividend, but at the discretion of
the board of directors.
Preferred Stock has preference over
common stock in the payment of
dividends and claims on assets.
4.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Preferred Stock Valuation
DivP DivP DivP
V= (1 + kP)
+ (1 + k + ... +
P) (1 + kP)¥
1 2
¥ DivP
=S or DivP(PVIFA k )
t=1 (1 + kP) t
P, ¥
This reduces to a perpetuity!
V = DivP / kP
4.25 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Preferred Stock Example
Stock PS has an 8%, $100 par value
issue outstanding. The appropriate
discount rate is 10%. What is the value of
the preferred stock?
DivP = $100 ( 8% ) = $8.00.
kP = 10%.
V = DivP / kP = $8.00 / 10%
= $80
4.26 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Common Stock Valuation
Common stock represents a
residual ownership position in the
corporation.
• Pro rata share of future earnings
after all other obligations of
the firm (if any remain).
• Dividends may be paid out of
the pro rata share of earnings.
4.27 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Common Stock Valuation
What cash flows will a shareholder
receive when owning shares of
common stock?
(1) Future dividends
(2) Future sale of the
common stock shares
4.28 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Dividend Valuation Model
Basic dividend valuation model accounts
for the PV of all future dividends.
Div1 Div2 Div¥
V= (1 + ke)1 + (1 + ke)2 + ... + (1 + ke)¥
¥ Divt Divt: Cash Dividend
=S (1 + ke)t at time t
t=1
ke: Equity investor’s
required return
4.29 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Adjusted Dividend
Valuation Model
The basic dividend valuation model
adjusted for the future stock sale.
Div1 Div2 Divn + Pricen
V= (1 + ke)1 + (1 + ke)2 + ... + (1 + k )n e
n: The year in which the firm’s
shares are expected to be sold.
Pricen: The expected share price in year n.
4.30 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Dividend Growth
Pattern Assumptions
The dividend valuation model requires the
forecast of all future dividends. The
following dividend growth rate assumptions
simplify the valuation process.
Constant Growth
No Growth
Growth Phases
4.31 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Constant Growth Model
The constant growth model assumes that
dividends will grow forever at the rate g.
D0(1+g) D0(1+g)2 D0(1+g)¥
V = (1 + k )1 + (1 + k )2 + ... + (1 + k ) ¥
e e e
Eq. 4.13
D1: Dividend paid at time 1.
D1
= g: The constant growth rate.
(ke - g) ke: Investor’s required return.
4.32 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Constant Growth Model
4.33 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Constant Growth
Model Example
Stock CG has an expected dividend
growth rate of 8%. Each share of stock
just received an annual $3.24 dividend.
The appropriate discount rate is 15%.
What is the value of the common stock?
D1 = $3.24 ( 1 + 0.08 ) = $3.50
VCG = D1 / ( ke - g ) = $3.50 / (0.15 - 0.08 )
= $50
4.34 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Zero Growth Model
The zero growth model assumes that
dividends will grow forever at the rate g = 0.
D1 D2 D
VZG = + + ... +
¥
(1 + ke)1 (1 + ke)2 (1 + ke)¥
D1 D1: Dividend paid at time 1.
=
ke ke: Investor’s required return.
4.35 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Zero Growth
Model Example
Stock ZG has an expected growth rate of
0%. Each share of stock just received an
annual $3.24 dividend per share. The
appropriate discount rate is 15%. What is
the value of the common stock?
D1 = $3.24 ( 1 + 0 ) = $3.24
VZG = D1 / ( ke - 0 ) = $3.24 / (0.15 - 0 )
= $21.60
4.36 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases Model
The growth phases model assumes
that dividends for each share will grow
at two or more different growth rates.
n D0(1 + g1) t ¥ Dn(1 + g2)t
V =S + S (1 + ke)t
t=1 (1 + ke) t
t=n+1
4.37 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases Model
Note that the second phase of the
growth phases model assumes that
dividends will grow at a constant rate g2.
We can rewrite the formula as:
n D0(1 + g1)t 1 Dn+1
V =S +
(1 + ke)n (ke – g2)
t=1 (1 + ke)t
4.38 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
Stock GP has an expected growth
rate of 16% for the first 3 years and
8% thereafter. Each share of stock
just received an annual $3.24
dividend per share. The appropriate
discount rate is 15%. What is the
value of the common stock under
this scenario?
4.39 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
0 1 2 3 4 5 6
D1 D2 D3 D4 D5 D6
Growth of 16% for 3 years Growth of 8% to infinity!
Stock GP has two phases of growth. The first, 16%,
starts at time t=0 for 3 years and is followed by 8%
thereafter starting at time t=3. We should view the time
line as two separate time lines in the valuation.
4.40 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
0 1 2 3 Growth Phase
#1 plus the infinitely
long Phase #2
D1 D2 D3
0 1 2 3 4 5 6
D4 D5 D6
Note that we can value Phase #2 using the
Constant Growth Model
4.41 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
V3 = D 4
We can use this model because
dividends grow at a constant 8%
k-g rate beginning at the end of Year 3.
0 1 2 3 4 5 6
D4 D5 D6
Note that we can now replace all dividends from
year 4 to infinity with the value at time t=3, V3!
Simpler!!
4.42 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
0 1 2 3 New Time
Line
D1 D2 D3
0 1 2 3 D4
Where V3 =
V3 k-g
Now we only need to find the first four dividends
to calculate the necessary cash flows.
4.43 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
Determine the annual dividends.
D0 = $3.24 (this has been paid already)
D1 = D0(1 + g1)1 = $3.24(1.16)1 =$3.76
D2 = D0(1 + g1)2 = $3.24(1.16)2 =$4.36
D3 = D0(1 + g1)3 = $3.24(1.16)3 =$5.06
D4 = D3(1 + g2)1 = $5.06(1.08)1 =$5.46
4.44 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
We determine the PV of cash flows.
PV(D1) = D1(PVIF15%, 1) = $3.76 (0.870) = $3.27
PV(D2) = D2(PVIF15%, 2) = $4.36 (0.756) = $3.30
PV(D3) = D3(PVIF15%, 3) = $5.06 (0.658) = $3.33
P3 = $5.46 / (0.15 - 0.08) = $78 [CG Model]
PV(P3) = P3(PVIF15%, 3) = $78 (0.658) = $51.32
4.45 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
Finally, we calculate the intrinsic value by
summing all of cash flow present values.
V = $3.27 + $3.30 + $3.33 + $51.32
V = $61.22
3 D0(1 +0.16)t 1 D4
V=S (1 +0.15) t
+
(1+0.15)n (0.15–0.08)
t=1
4.46 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases
Model Example
Stock GP has an expected growth
rate of 15% for the first 4 years and
5% thereafter. Each share of stock
just received an annual $50 dividend
per share. The appropriate discount
rate is 13%. What is the value of the
common stock under this scenario?
4.47 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases Model
Example-2
Determine the annual dividends.
D0 = $50 (this has been paid already)
D1 = D0(1 + g1)1 = $50(1.15)1 =$57.500
D2 = D0(1 + g1)2 = $50(1.15)2 =$66.125
D3 = D0(1 + g1)3 = $50(1.15)3 =$76.044
D4 = D0(1 + g1)4 = $50(1.15)4 =$87.450
D5 = D4(1 + g2)1 = $87.450(1.05)1 =$91.823
4.48 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases Model
Example-2
We determine the PV of cash flows.
PV(D1) = D1(PVIF13%, 1) = $57.500 (0.885) = $50.888
PV(D2) = D2(PVIF13%, 2) = $66.125 (0.783) = $51.776
PV(D3) = D3(PVIF13%, 3) = $76.044 (0.693) = $52.698
PV(D4) = D4(PVIF13%, 4) = $87.450 (0.613) = $53.607
P4 = $91.823 /(0.13 - 0.05) = $1147.788 [CG Model]
PV(P4) = P4(PVIF13%, 4) = $1147.788(0.613)=$703.600
4.49 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Growth Phases Model
Example-2
Finally, we calculate the intrinsic value by
summing all of cash flow present values.
V = $50.888 + $51.776 + $52.698 + $53.607 + $703.600
V = $912.6
4 D0(1 +0.15)t 1 D5
V=S (1 +0.13) t
+
(1+0.13)n (0.13–0.05)
t=1
4.50 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Calculating Rates of
Return (or Yields)
Steps to calculate the rate of
return (or Yield).
1. Determine the expected cash flows.
2. Replace the intrinsic value (V) with
the market price (P0).
3. Solve for the market required rate of
return that equates the discounted
cash flows to the market price.
4.51 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Determining Bond YTM
Determine the Yield-to-Maturity
(YTM) for the annual coupon paying
bond with a finite life.
n
I MV
P0 = S (1 + kd )t
+
(1 + kd )n
t=1
= I (PVIFA k ) + MV (PVIF kd , n)
d,n
kd = YTM
4.52 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Determining the YTM
Julie Miller wants to determine the
YTM for an issue of outstanding
bonds at Basket Wonders (BW). BW
has an issue of $1,000 par value bond
with 10% annual coupon bonds with
15 years left to maturity. The bonds
have a current market value of $1,250.
What is the YTM?
4.53 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
YTM Solution (Try 9%)
$1,250 = $100(PVIFA9%,15) +
$1,000(PVIF9%, 15)
$1,250 = $100(8.061) +
$1,000(0.275)
$1,250 = $806.10 + $275.00
= $1,081.10
[Rate is too high, try lower
4.54 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
YTM Solution (Try 7%)
$1,250 = $100(PVIFA7%,15) +
$1,000(PVIF7%, 15)
$1,250 = $100(9.108) +
$1,000(0.362)
$1,250 = $910.80 + $362.00
= $1,272.80
[Rate is too low now, therefore, use
4.55
Interpolation]
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Interpolation
Interpolation is the estimation of
an unknown number that lies
somewhere between two known
numbers.
4.56 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Interpolation
iL = discount rate that is somewhat lower than the investment’s
YTM (or IRR)
iH = discount rate that is somewhat higher than the investment’s
YTM
PVL = present value of the investment at a discount rate equal to iL
PVH = present value of the investment at a discount rate equal to iH
PVYTM = present value of the investment at a discount rate equal
to the investment’s YTM, which (by definition) must equal the
investment’s current price
4.57 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Interpolation
4.58 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Determining the YTM
Consider a $1,000-par-value bond
with the following characteristics: a
current market price of $761, 12 years
until maturity, and an 8 percent
coupon rate (with interest paid
annually).
What is the YTM?
4.59 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.