Discussion Post FIN 609

docx

School

National University College *

*We aren’t endorsed by this school

Course

608

Subject

Finance

Date

Jan 9, 2024

Type

docx

Pages

Uploaded by MinisterOxide21079

Which valuation is more accurate; the market value or the intrinsic value of stock? discuss . In the realm of stock valuation, market value and intrinsic value offer distinct perspectives, each shaped by different influences (Chron Contributor, 2021). Market value represents the collective judgment of investors, reflecting their expectations regarding a company's future financial performance and risk. This valuation, easily determined for public companies, can be challenging for private firms due to the absence of a public market. In contrast, intrinsic value delves into a company's internal worth, incorporating a range of data, both public and proprietary. It is subjective, varying based on individual perspectives within the company, making it more intricate to calculate than market value (Chron Contributor, 2021). Determining the accuracy of these valuations is complex and context-dependent. Market value, influenced by external factors like market trends and investor sentiment, offers real-time insights but can be swayed by short-term fluctuations. Intrinsic value, while providing a deeper understanding of a company's fundamentals, relies heavily on subjective judgments. Investors often consider both valuations alongside other financial metrics, adopting a holistic approach to gain a comprehensive understanding of a stock's true worth (Chron Contributor, 2021). When there is uncertainty in the marketplace, what happens to yield spreads and why? Yield spreads play a crucial role in the bond market, serving as a measure of the difference between yields on various debt instruments with differing characteristics (Chen, 2020). These differences in yields are typically expressed in basis points or percentage points and can result from variations in maturities, credit ratings, issuers, or risk levels (Chen, 2020). For instance, the yield spread between a five-year Treasury bond yielding 5% and a 30-year Treasury bond yielding 6% would be 1% (Chen, 2020). Investors often evaluate non-Treasury bonds by comparing their yield spreads with those of comparable maturity Treasury bonds. Higher risk associated with a bond or asset class typically leads to a higher yield spread, compensating investors for the increased risk they undertake (Chen, 2020). This metric aids bond investors in assessing the expense level associated with a bond or a group of bonds and informs their investment decisions in the market (Chen, 2020). References Chen, J. (2020, October 10). Yield Spread: Definition, How It Works, and Types of Spreads. Investopedia. https://www.investopedia.com/terms/y/yieldspread.asp Chron Contributor. (2021, October 18). Difference Between Market Value and Intrinsic Value. Small Business - Chron.com. https://smallbusiness.chron.com/difference-between- market-value-intrinsic-value-69232.html

Week 3 If you were evaluating an investment opportunity, which technique would you use and why? In evaluating an investment opportunity, I would employ the options approach as discussed by Dixit and Pindyck (n.d.) in their article. This approach emphasizes that capital investments are essentially options, allowing companies the right but not the obligation to take action in the future based on evolving market conditions. Unlike traditional methods such as the Net Present Value (NPV) rule, which assumes investments are either reversible or immediate, the options approach recognizes the real-world complexities of irreversibility and uncertainty (Dixit & Pindyck, n.d.). The NPV rule, a commonly taught method, has limitations. It often oversimplifies investment decisions, assuming fixed scenarios without accounting for the ability to delay or abandon projects based on future information. The options approach, on the other hand, acknowledges the value of waiting for more data and incorporates the concept of real options. Investments are akin to call options, granting the right to undertake profitable projects in the future. The ability to delay investments when uncertainty is high or to expedite them when they create additional future options is crucial. For instance, research and development (R&D) projects, despite appearing uneconomical in isolation, may create valuable options for future investments, a factor often overlooked in NPV analyses (Dixit & Pindyck, n.d.). Furthermore, the options approach underscores the importance of considering opportunity costs in investment decisions. When a company makes an irreversible investment, it effectively forfeits the opportunity to wait for new information that might affect the project's desirability. This lost option value needs to be included in the cost of the investment, modifying the traditional NPV calculation (Dixit & Pindyck, n.d.). In conclusion, the options approach offers a more nuanced and realistic perspective on investment decisions, allowing for a better understanding of the complexities involved. By incorporating the ability to delay, abandon, or expedite investments based on evolving market conditions, this approach provides a more comprehensive framework for evaluating investment opportunities.

When evaluating investments, you can get data from engineering, marketing and sometimes accounting. Do you think any of these organizations have internal biases? If so, as a member of the finance department, how would you deal with them? Yes, it is possible for engineering, marketing, and accounting departments to have internal biases when providing data for investment evaluations. Engineering teams might be overly optimistic about the feasibility and costs of implementing a new project, while marketing departments might exaggerate market demand and potential sales. Accounting departments could have biases related to cost estimation and financial projections. These biases can stem from various factors, such as internal pressures to meet targets, enthusiasm for new initiatives, or a desire to secure resources for their respective departments. As a member of the finance department, it is crucial to approach these biases critically and implement strategies to mitigate their impact on investment evaluations: 1. Cross-Verification of Data: Independently verify the data provided by these departments. Utilize external consultants or third-party experts to validate technical and market- related information. Cross-referencing internal data with external sources can provide a more objective view. 2. Encourage Open Communication: Foster an open communication environment where employees feel comfortable discussing their assumptions and methodologies. Encourage them to challenge each other’s ideas constructively. This can help in identifying potential biases and addressing them collaboratively. 3. Scenario Analysis: Conduct scenario analysis by considering different assumptions and scenarios provided by different departments. Assess the potential impact of variations in engineering, marketing, and accounting data on the investment outcomes. This helps in understanding the range of possible outcomes and associated risks. 4. Independent Evaluation Teams: Form interdisciplinary teams that include members from engineering, marketing, accounting, and finance. Having diverse perspectives within the evaluation team can help in identifying biases and ensuring a more balanced evaluation process. 5. Utilize Historical Data: Rely on historical data and past performance metrics to validate assumptions made by different departments. Analyzing the outcomes of previous similar projects can provide valuable insights into the accuracy of internal projections. 6. Sensitivity Analysis: Perform sensitivity analysis to assess the impact of changes in key assumptions on the investment metrics. Identify which assumptions have the most significant influence on the project's viability. This helps in focusing efforts on validating critical data points.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

7. Involve Higher Management: Involve senior management or a steering committee in the evaluation process. Their objective perspective can help in challenging biases and ensuring a more rigorous evaluation of investment proposals. By implementing these strategies, the finance department can navigate internal biases effectively, leading to more informed and reliable investment decisions. References: Dixit, A. K., & Pindyck, R. S. (1995, May). The Options Approach to Capital Investment. Harvard Business Review. Retrieved from https://hbr.org/1995/05/the-options-approach- to-capital-investment Week 4 Explain how the use of leverage can increase shareholder’s wealth. Leverage, as explained by Hayes (2023), involves the strategic use of borrowed capital to expand a firm's asset base and generate returns on risk capital. This concept is significant for both investors and companies, offering avenues to enhance shareholder wealth. For Investors: Investors can employ leverage to magnify their potential returns on investments (Hayes, 2023). By utilizing financial instruments such as options, futures, and margin accounts, investors can amplify their gains. For instance, borrowed money used to invest in stocks or financial assets can significantly increase profits if the investments perform well. Although this approach enhances potential returns, it also escalates the associated risks due to the involvement of borrowed capital. For Companies: Companies can utilize leverage to finance their assets and investments (Hayes, 2023). Instead of issuing additional stock, they can opt for debt financing. Borrowing funds enables businesses to invest in various operations, projects, or expansions. When these investments generate profits surpassing the cost of borrowing, shareholder value increases. Debt strategically employed allows companies to undertake profitable ventures, leading to higher earnings per share and improved stock prices, thereby benefiting shareholders. In summary, leverage, as outlined by Hayes (2023), offers investors opportunities to maximize returns and allows companies to pursue growth initiatives without diluting existing shareholders' equity. However, it's crucial to manage leverage prudently to balance the potential benefits with the associated risks, ensuring sustainable growth of shareholder wealth.

Leverage can also impact you in your personal life. Explain how you can use it to your advantage. Leverage can be a powerful tool in personal finance, offering individuals the opportunity to amplify their financial capabilities and achieve various goals. One significant advantage of leverage is its role in investment opportunities. By borrowing capital, individuals can invest in assets like real estate or stocks with a fraction of their own money. The potential returns are calculated based on the total investment, allowing individuals to benefit from the asset's full value appreciation, not just their initial investment. This strategy, often seen in real estate, can significantly enhance wealth creation over time. Entrepreneurship also benefits from leverage. Entrepreneurs frequently leverage borrowed funds to initiate or expand their businesses. These financial resources enable them to hire skilled staff, develop innovative products, and invest in marketing efforts. If the business succeeds, the returns can far exceed the cost of the borrowed capital, leading to substantial profits and business growth. Additionally, borrowing for education or skill development can be a form of leverage, allowing individuals to enhance their knowledge and expertise, potentially leading to higher income in the future. Moreover, leverage provides opportunities for diversification and tax advantages. Diversifying investments across different assets or sectors can spread risk, enhancing the potential for long-term gains. Additionally, certain types of loans, like mortgages, offer tax deductions on the interest paid. This tax benefit lowers the overall cost of borrowing, making leverage a more financially viable option. However, while leverage can be advantageous, careful consideration, risk assessment, and financial planning are essential to mitigate potential downsides and ensure long-term financial stability. Reference Hayes, A. (2023, May 12). What Is Financial Leverage, and Why Is It Important? Investopedia. Retrieved from https://www.investopedia.com/terms/l/leverage.asp#:~:text=Leverage %20refers%20to%20the%20use,issue%20stock%20to%20raise%20capital .