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CHAPTER 8 Valuation and Rates of Return Differentiate among the definitions of “value” and explain the importance of intrinsic value in making financial decisions. Explain how intrinsic value is calculated by considering the size, timing, and perceived riskiness of the cash flows. | 8 Valuation and Rates ofReturn After studying this chapter you should be able to 1. Differentiate among the definitions of value and explain the importance of intrinsic value in making financial decisions. 2. Explain how intrinsic value is calculated by considering the size timing and perceived riskiness of the cash flows. 3. Explain the concept of required rate of return and calculate this rate using the Capital Asset Pricing Model CAPM . 4. Show how any security common or preferred stocks bonds etc. can be valued in Excel or by hand. 5. Calculate the various bond return measures in Excel. Determining the value of financial assets is important to both investors and corporate financial managers. The obvious reason is that nobody wants to pay more than an asset is worth since such behavior would lead to lower returns. Less obvious but equally important is that we can draw some valuable conclusions from the observed prices of assets. We will examine one of these conclusions in detail in the next chapter when we use the value of corporate securities to determine the required rate of return on investments. 213 214 Valuation and Rates of Return What Is Value The term value has many different meanings depending on the context in which it is used. For our purposes there are four important types of value. Generally value can be defined as the amount that a willing and able buyer agrees to pay for an asset to a willing and able seller. In order to establish the value of an asset it is important that both the buyer and seller be willing and able. Otherwise no legitimate transaction can take place and value cannot be determined without an exchange. Notice that we did not say that the value of an asset is always the same as its price. Price and value are distinct though related concepts. The price of an asset can be greater than its value in which case we say that the asset is overvalued or over-priced less than its value under-valued or equal to its value fairly-valued . Book
