second

year
Financial Management
chapter Six and Seven

(FMI )
2023
Romario Khaled
01271535731
01149154059
 second year [FINANCIAL MANAGEMENT CHAPTER]

Chapter ( six )
Bond valuation
1. Corporate Bonds foundation ‫تاسٌس السند‬
2. Valuation Fundamentals. ‫طرق التمٌم‬
3. The basic valuation model to bonds.
4. Bond Value Behavior.
5. Current yield and Yield to maturity (YTM ) ‫العائد الحالً والعائد عند االستحماق‬

* in general we have two kind of bond government bond & corporate bond

1. Corporate Bonds foundation ‫تاسيس السند‬

- A corporate bond :
is a long-term debt instrument ‫ اداة‬indicating that a corporation has borrowed a certain
amount of money and promises to repay it in the future under clearly defined terms. ‫بموجب‬
‫ ( شروط محددة بوضوح‬Principle and interest )
- Most bonds are issued with maturities of 10 to 30 years and with a par value, principle
or face value 1000$ ‫المٌمة االسمٌة اللً مطبوعه علً الورلة‬

- The coupon interest rate ‫ الفوايد المستحقة علي السند‬:

is represents the percentage of the bond’s par value that will be paid annually, typically
in two equal semiannual payments,
as interest as (par value 10 % annual interest rate T ) (PRT)

- it may be paid annually , semi or quarterly .

- The bondholders, who are the lenders, are promised the semiannual interest payments
and, at maturity, repayment of the principal amount.

Bond yields : ‫العائد علي السند‬

The yield, or rate of return, on a bond is frequently used to assess a bond’s performance
over a given period of time
1. Current yield (CY).‫العائد الجاري‬
2. Yield to maturity (YTM) ‫العائد عند االستحماق‬
3. Yield to call (YTC)
4. Yield to hold (YTH).

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COMMON TYPES OF BONDS

unsecured
( debentures, subordinated debentures, and income bonds)
secured.
(mortgage bonds, collateral trust bonds, and equipment trust certificates)

2. Valuation Fundamentals. ‫ ( طرق التقيم‬Find V0 or apresent value )

- Modern theory of finance : valuation is the process that links risk and return to
determine the value of an assets .
- Discounting of Future Cash Flow by inflation of required rate of return
ً‫ٌعنً من االخر عشان الٌم اي حاجة محتاج اشوف هً هتجٌبلً عائد اٌه فً المستمبل مثال هستثمر شهادة استثمار هنجٌبل‬
. ‫ السوال بمً انا دلولتً اشتري الشهادة دي بكام عشان ابمً كسبان‬. ‫ جنٌه فوائد‬011 + ‫ جنٌه‬0111 ‫كمان سنه‬
‫ جنٌه كمان سنه‬01 ‫هعمل ده عن طرٌك انً اشوف هً هتجٌبلً كام فً المستمبل بس بمٌمة الفلوس بتاعت النهاردة ٌعنً مثال‬
. ‫ جنٌه كمان سنتٌن‬01 ‫اكبر من‬
‫ رلم واحد هشوف انا هحصل منها كام فً المستمبل مثال‬-
(CFi) ‫ جنٌه فواٌد‬011 + (CFn or M ) Maturity ً‫ جنٌه أساس‬0111
(n) ‫ احدد الولت اللً هحصل فٌه‬-
( Risk or Inflation Or RD or Rs ) ( r ) ‫ العوامل المؤثره علً لٌمه الفلوس‬-
Key Inputs
There are three key inputs to the valuation process:
(1) cash flows (returns), (CF)
(2) timing, (n)
(3) a measure of risk, which determines the required return.
(RRR/ inflation rate / rd / r )
The basic valuation model : is Discounted cash flow model (DCF)

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Ex 1 : Assume that there is a 10% coupon interest rate 5 year bond with a 1000 EGP par value that
pays interest annually find the value of bond If required rate of return 8% .

Solution
Given :
- (Annual Interest = 1000 × 10% = 100 EGP), (CFi)
- n From 1 to 5
-N5
- Maturity = 1000 LE
- r or RRR or Inflation Rate = 8 %
1)v0 =

= 1.079.85 EGP

‫ جنٌه ده الرلم اللً لو انت مستثمر دي اعلً لٌمه ممكن تشتري بٌها الشهادة و لو انت الشركة اللً بتبٌع‬0.197..1 ‫كدة ال‬
. ‫الشهادة ده الل رلم تمدر تبٌع بٌه الدٌن‬

3. The valuation model to bonds. ‫تحديد سعر السند‬

Bond Value Behavior.
1 – Relation between RRR and bond value

interest rate RRR Selling Maturity

Case (Return) (Risk) Price
1 - Face value 10% 10 % 1000 LE 1000 LE
2 – Discount 10% 12 % 887 LE 1.000 LE
3 - Premium 10% 8% 1.134LE 1.000 LE

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- If the required rate of return is equal to the bond coupon interest rate then the bond
value will be equal to the par value and we say that the bond is selling at par.

- If the required rate of return is lower than the bond coupon interest rate then the bond
value will be higher than the par value and we say that the bond is selling at premium.

-If the required rate of return is higher than the bond coupon interest rate then the bond
value will be lower than the par value and we say that the bond is selling at a discount.

2 – relation between bond value and time to maturity

interest
At At issuance
Case RRR issuance Variation Variation
rate 10 Years
5 Years
1 - Face value 10% 10 % 1000 LE 0 1000 LE 0
2 – Discount 10% 12 % 952LE - 48 901 LE -99
3 - Premium 10% 8% 1.115 LE 115 1.052 LE 52

- the longer the time to maturity, the higher the risk (assuming everything constant) the
higher the required rate of return, the lower the value.

- that the shorter the time to maturity, the lower interest rate risk (assuming everything
constant) than long maturities.

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.Summary ( factors that affect Bond value )

1 –impact of Time to maturity

Shorter is cheaper than Longer the time of maturity
2 - Impact of the Cost of Money (RRR) and IR
IR (return ) = RRR (Risk ) (Par Value )
IR (return ) > RRR (Risk ) (premium )
IR (return ) < RRR (Risk ) ( Discount )

3 - Impact of Offering Size ( Reading only )

The size of the bond offering also affects the interest cost of borrowing but in an inverse
manner: Bond flotation and administration costs per dollar borrowed are likely to
decrease with increasing offering size. On the other hand, the risk to the bondholders
may increase, because larger offerings result in greater risk of default.

4 - Impact of Issuer’s Risk ( Reading only)

The greater the issuer’s default risk, the higher the interest rate.

4-Types of bond
1 – perpetual bond ‫ملوش تارٌخ استحماق محدد‬
2 – maturity bond ‫لٌه تارٌخ استحماق محدد‬

1 – perpetual bond ‫ملوش تاريخ استحقاق محدد‬

-The main characteristic of perpetual bonds is that it has a fixed amount of interest
(return) and it has no maturity date.
- The cash flow of such type of bonds consists only of the periodical interest amounts
the value of this type of bonds is equal to the present value of those expected cash .
- No Time ( n or N ) and no maturity

V0 or present value =

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Ex 1 : Assume that there is a 10% coupon interest rate perpetual bond with a 1000 EGP par value
that pays interest annually (I= 1000 × 10% = 100 EGP),
find the value of bond under the following three assumptions of the
required rate of return
1) 8% 2) 10% 3) 12%
Solution

V0 or present value =
The bond "value under the assumptions:
1) The value of the bond assuming the required rate of return: 8 %
B0= (100/8%) = 1250 EGP
2) The value of the bond assuming the required rate of return: 10 %
B0= (100/10%) = 1000 EGP
3) The value of the bond assuming the required rate of return 12 %
Bo = (100/12%) = 833 EGP.
2 – maturity bond ‫( زي اول مثال خدناه ) ليه تاريخ استحقاق محدد‬
It has
- a fixed amount of interest (return) paid annually or semi-annually
- it has fixed maturity date (a specific maturity date).
In this case, the value of this bond can be calculated using the following equation:

Ex 2 : Assume that there is a 10% coupon interest rate 5 year bond with a 1000 EGP par value that
pays interest annually (I= 1000 × 10% = 100 EGP),
find the value of bond under the following three assumptions of the
required rate of return
1) 8% 2) 10% 3) 12%

Solution
1)B0 =

= 1079.85 EGP

2)B0 =

= 1000 EGP

3)B0 =

= 927.9 EGP

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Note that
- the value of the bond at time zero is equal to the present value cash flow which is
expected to be received out of this bond over a certain period of time.

Such present value consists of two components:

1. The total present value of the amount of interest to be received each year during this
period
2. The present value of the principle (par value) which will be received
at the maturity date
- So Another way to find the value of the bond using PVIF and PVIFA

as follows:

B0 =

PVIF = PVIFA =

OR
From tables

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Ex 3 : Assume that there is a 10% coupon interest rate 5 year bond with a 1000 EGP par value that
pays interest annually (I= 1000 × 10% = 100 EGP),
find the value of bond under the following three assumptions of the
required rate of return
1) 8% 2) 10% 3) 12%
Solution
B0 =
1–

PVIF = = .6806 PVIFA =

B0 = 100 3.9927 + 1000 .6806 = 1079. 87 EGP

2–

PVIF = = .6209 PVIFA =

B0 = 100 3.7908 + 1000 .6209 = 1000 EGP

3–

PVIF = = .5674 PVIFA =

B0 = 100 3.6048 + 1000 .5674 = 927.88 EGP

VIP
For semiannual :
1 - Interest rate (I) will divided by 2
2 – number of payment (n) multiplied by 2
3 – RRR or discount rate (rd) will divided by 2

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Ex 4 : Assume that there is a 10% coupon interest rate 5 year bond with a 1000 EGP
par value that pays interest semi annually (I= 1000 × 10% = 100 EGP),
find the value of bond under the following three assumptions of the required rate of
return 10 %
Solution
Given
I will be 5 % and interest will be 1000 * 5% = 50 LE
n will be 10
RRR = 10 % / 2 = 5 %

B0 =

= 1000 EGP
OR

By using B0 =

PVIF = = .6139 PVIFA =

B0 = 50 * 7.7217 + 1000 * .6139 = 1000 EGP

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5. Current yield and Yield to maturity (YTM ) ‫العائد الحالي والعائد عند االستحقاق‬

1- . Current yield ‫العائد الحقيقي او العائد الحالي‬

- it is a measure of bond's cash return for a year

For example the market price for a bond EGP1079.85, its par value 1000 and paying 10%
interest rate so the current yield of this bond is

(100/1079.85%) = 9.25%

2 - Yield to Maturity (YTM) ‫العائد عند االستحقاق‬

- it is the rate of return that investors earn if they buy a bond at a specific price and hold it
until maturity (Assumes that the issuer makes all scheduled interest and principal
payments as promised)
‫هو معدل العائد الذي ٌكسبه المستثمرون إذا اشتروا سندًا بسعر محدد واحتفظوا به حتى تارٌخ االستحماق (على افتراض أن‬
) ‫)المدٌون سوف ٌسدد جمٌع الفوائد و المٌمة كاملة‬
- The yield to maturity (YTM) can be calculating by using the basic bond valuation model,
and solve the equation
for the required rate of return which will be in this case the YTM
(YTM = rd) and it would be the un- known variable in the equation since the bond's value
is known.
Note that:
- The yield to maturity on a bond with a current price equal to its par value ( issued at
face value ) will always equal the coupon interest rate.
- When the bond value differs from par( Premium or discount ), the yield to maturity
will differ from the coupon interest rate.

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Chapter (Seven)
Stock valuation
1 - Differences between debt and Equity
- Debt : includes all borrowing acquired by a firm, including bonds, and is repaid
according to a fixed schedule of payments.(liability)( interest )
- Equity : consists of funds provided by the firm's owners (investors(new) or stockholders
(old ) ) that are repaid subject to the firm's performance (dividends ) .
- Debt financing : is obtained from creditors
- Equity financing : is obtained from investors who then become part owners of the
firm.
- Creditors (lenders or debt holders) have a legal right to be repaid,
- investors only have an expectation of being repaid.
- Key differences between debt and equity capital can be represented as follows:

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2 - Common stock and preferred stock valuation :

We have two method of valuation

A- the discounted cash flow approach

Based on Discounting the expected dividends or free cash flow
1 – Dividend model
2 – Free cash flow model
B – the multipliers approach
Based on calculating the price multipliers for certain accounting profit measurements
such ( EPS ,DPS,EBITDA)

A- the Discounted cash flow approach (bond ‫) زي بتاع ال‬

Discount the future cash flow by Risk Factor
1 – Dividend model
We will consider three models here:
1 - zero growth
2- constant growth
3- variable growth.

1 - zero growth (g = 0 )(mostly is preferred stock ) No PS in Egypt

The simplest approach to dividend valuation assumes a constant, non growing dividend
D1 = D2= ……= D∞

- the value of a share of stock would equal the present value of a perpetuity of D1
dollars discounted at a rate rs
EX1 : Chuck Swimmer estimates that the dividend of Denham Company an established textile
producer, is expected to remain constant at $3 per share indefinitely ‫الجل غير مسمي‬. If his required
return on its stock is 15%, what is the stock’s value ?

Solution

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2- constant growth
The most widely cited ‫ االكثر انشارا‬dividend valuation approach, it assumes that dividends
will grow at a constant rate, but a rate that is less than the required return.

( The assumption that the constant rate of growth, g, is less than the required return )

OR

D1 = next year dividend = Do

rs = RRR g = constant growth rate
Ex 2 : Lamar Company, a small cosmetics company, from 2010 through 2015 paid the following
per-share dividends and RRR = 15% : find P2015

Solution
We need to find ( g & D1 )
To find g

√ -1=g
OR
√ -1 = 7%
1+ g = √ =1.07
g = 1.07 – 1 = 7 %

To find D1: Do (1+g)

P2015 =

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3 - Variable-Growth Model (g is variable ) ( 4 steps )

1 – Find Dividends for first growth rate years
2 – Find the Present value of step one
3 – Find the next of ending year dividends then find stock value at end year and Find the
Present value of step three
4 – add step 2 plus step 3

Ex 3 : Victoria Robb is considering purchasing the common stock of Warren

Industries, a rapidly growing boat manufacturer. She finds that the firm’s most recent
(2015) annual dividend payment was $1.50 per share. Victoria estimates that these
dividends will increase at a 10% annual rate, g1, over the next 3 years (2016, 2017,
and 2018) because of the introduction of new boat. At the end of the 3 years (the end
of 2018), she expects the firm’s mature product line to result in a slowing of the
dividend growth rate to 5% per year, g2, for the future. Victoria’s required return, rs,
is 15%. To estimate the current (end-of-2015)
Solution

Present G= 10 % G= 5 %
value D2016 D2017 D2018 2019 To infinity
D 1.5 * ( 1.5 * ( 1.5 * (
Step 1 1.65 $ 1.82 $ 2$
1.43 $

Step 2 1.37 $
1.32 $
D 2019 =2$*(1+.05)
= 2.1$
Step 3 P2019 =
13.81 $

Step 4 17.93$

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2 – Free cash flow model (FCF)

Assets (Value of Company ) = Liability ( value of Debt ) + OE ( Value of Equity )
VC = VD+(VS+VP)
We need to Find value of Common stock (VS)
VS = VC – VD -VP
EX 4 : Dewhurst, Inc., wishes to determine the value of its stock by using the free cash
flow valuation model.

Solution
Present
value FCF2016 FCF2020 FCF2018 FCF2019 FCF2020
Step 400.000$ 450.000$ 520.000$ 560.000$ 600.000$
1
366,972$

Step 378,788 $
2 401,544 $
396,601 $
389.959 $
FCF 2021 TO infinity

FCF 2021 = FCF2020 *(1+g)

= 600.000 *(1+3%)
= 618.000 $
Present value of FCF2021 =

Step
3

6.694.293$
Step
8.628.157$ = VC
4

VS = VC – VD –VP
VS = 8.628.157 – 3.100.000 – 800.000 = 4.726.426 $
Num of CS = 300.000 CS
Value of CS = 4.726.426 / 300.000 = 15.75 $ / CS
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B – the multipliers approach

Based on calculating the price multipliers for certain accounting profit measurements
such ( EPS ,DPS,EBITDA)
1 - Book value per share
The amount per share of common stock that would be received if all of the firm’s assets
were sold for their exact book (accounting) value and the proceeds remaining after
paying all liabilities (including preferred stock) were divided among the common
stockholders.

Ex5 : At year-end 2015, Lamar Company’s balance sheet shows total assets of $6
million, total liabilities and preferred stock of $4.5 million, and 100,000 shares of
common stock outstanding. Its book value per share would therefore be

Because this value assumes that assets could be sold for their book value, it may not
represent the minimum price at which shares are valued in the marketplace.

2 - liquidation value per share ( fair value of assets )more realistic

The actual amount per share of common stock that would be received if all of the firm’s
- assets were sold for their market value, liabilities (including preferred stock) were
paid, and any remaining money were divided among the common stockholders.
- realistic than book value—because it is based on the current market value of the
firm’s assets—but it still fails to consider the earning power of those assets.

Exp 6 : Lamar Company found on investigation that it could obtain only $5.25
million if it sold its assets today. The firm’s liquidation value per share would
therefore be

Note : Ignoring liquidation expenses, this amount would be the firm’s minimum
value.

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3 – price per earnings multiple approach

Ex7 : Lamar Company will earn per share $2.60 next year (2016). This expectation is
based on an analysis of the firm’s historical earnings trend and of expected economic
and industry conditions. She finds the price/earnings (P/E) ratio for firms in the same
industry to averag 7.

Price = 2.6 * 7 = 18.2 $

4 - Decision Making and Common Stock Value

Valuation equations measure the stock value at a point in time based on expected return
and risk.
Any decisions of the financial manager that affect these variables can cause the value of
the firm to change.

1 – change in Expected return ( dividends )

If it increase it will increase price and If it decrease it will decrease price

2 – change in RRR or Rf or Rd
If it decrease it will increase price and If it increase it will decrease price

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Ex 8 : we found Lamar Company to have a share value of $18.75. On the following

day, the firm announced a major technological breakthrough that would revolutionize
its industry. Current and prospective stockholders would not be expected to adjust
their required return of 15%, but they would expect that future dividends will
increase. Specifically, they expect that although the dividend next year, D1, will
remain at $1.50, the expected rate of growth thereafter will increase from 7% to 9%.
Solution

Shares value (new ) =

If it increase it will increase price and If it decrease it will decrease price

Ex 9 : Assume that Lamar Company’s 15% required return resulted from a risk-free
rate of 9% and a risk premium of 6%. With this return, the firm’s share value
was calculated in Example 8 $18.75.
Now imagine that the financial manager makes a decision that, without changing
expected dividends, causes the firm’s risk premium to increase to 7%. Assuming
that the risk-free rate remains at 9%,
Solution
RRR = Rf + (risk premium ) = 9 % + 7% = 16 %

Shares value (new ) =

If it decrease it will increase price and If it increase it will decrease price

3 - Combined effect
Ex 10 : According to Ex 8 and Exp 9 data RRR change to be 16 % and dividends
growth increased to be 9 %

Shares value (new ) =

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