That's it. I'll give you the brain parts.
So that is
the debt valuation. Question? Just a refresher.
What you have learned before, right? And
debt valuation is quite simple because it's
cash flow is common.
It's very normal. There's no uncertainty
involved in the cash flows. And maybe the
only tricky part is to figure out what is the
discount rate here. Okay, so the second part
is about the equity. Remember when we use
equity in the stock interchangeably.
Okay, so that is the right bottom part. And
usually it's not preferred to equity is much less
common than the common equity. So now just
let's us focus on the common equity. We try to
value the common equity, common stocks.
Again, we need to start from the numerator.
Okay, we need to start from what is the cash
flows that is generated by holding the equity.
So this is a general cash flow and unlike
debts, which has specific maturity, for debts or
for equity, essentially it can last forever.
Suppose a farm does not go bankrupt, so your
forecast of the cash flow should be in one
period what would be the cash flow generated
in two periods, three periods. And what is a
cash flow here? In the more traditional way,
we think by holding the common equity, you
have claim to the farm's dividends.
So the dividends are the cash flows that are
generated by holding this stock. And this will
also give you the so -called dividend discount
model. We view the cash flow to equity
holders as the dividends.
Now, these are the dividends. I mentioned
here the bonds has finite maturity rates. But
the equities could be infinitely lived. Question.
Do we have infinitely lived bonds? Do we?
Yes or no? Strictly speaking, the first bullet
point here is not correct.
Bonds, some bonds have infinitely maturity.
Remember what's that quote? Perpetual
bonds, right? Perpetual. Actually, more
recently, the New Zealand, they issued the
central bank, they issued the perpetual bonds.
OK, so that's the first point. And second,
unlike the interest in the principle for the bond
holders, that's for sure that's pre -specified.
The dividend payments are not promised.
Who decides the dividend payments?
Who decides the firm's dividend payments?
Both of the directors. They need to prove that.
Financial manager, you can see. The CEO of
financial manager, they decide the dividend
payments. So you can see that is at the
discretion of the firm management.
So it is not a promise. When you buy the
Apple share, you not sure whether they're
going to pay the dividends. And more recently,
META, the Facebook's parent firm, for the first
time, they pay out the dividends.
And that's a shock to the market, because like
Facebook, they never paid the dividend
before. So anyway, just compared with the
certain interest in the principal, the dividend
payments are not promised.
So that's give you some difficulty in estimating
the dividends. Now, how about the numerator
or denominator parts? So we have learns. We
need to use the cost of equity to discount the
cash flows for the equity holders, for the
stockholders.
And we've learned that more rigorously, we
should use it. we should use the KaPAN
capital SM pricing model to estimate this cost
of equity. Okay. Now I just write down the
formula, but we will review it in more detail in
the next lecture.
So what KaPAN tells you is that the cost of
equity, okay, or from the equity holder's
perspective, this required return of holding the
firms stock should be equal to this equation,
which equals to the risk -free rates plus risk -
free rate.
Okay. So this part is a risk -free rate. And risk
-free rate is equal to beta of the stock times
the market risk -free rate. So you can think of
this as the quantity of the risk, and this is the
price of the risk.
So the product of the two will give you the
total risk premium of this individual stocks.
Okay. So we will review it in more detail next
lecture, but this just give you some like brief
review. Now with KaPAN, we can determine
the cost of equity and going back to our
general formula, our very powerful general
formula.
Now we somehow get a sense of the
numerator cash flows and the denominator
discount rates, so that's the value of the stock
or the stock price. It's just the summation of all
the future discounted dividend.
Okay. So this will be the formula for the stock
price. And the total market value is just the
stock price times the number of shares. Okay.
And this will give you this e part here. Okay.
This is the market value of this equity.
Okay. Now we have the market value of the
debt, market value of equity, and the firm
value of the summation of the two. And some
more words about the equity parts. So we
have briefly mentioned nearest difficulty
compared with the bonds valuation near some
difficulty in estimating the numerator cash
flows.
First is uncertain. Second, you don't know the
time. You don't know when they're going to
issue the dividends. You don't know the
amounts. You don't know how much you will
get. So all these are uncertain there.
So how do we do that usually? And these are
infinite terms. So how do we estimate this
dividends if we want to use this approach to
value the stock price? So in general what we
do here is a following.
So we can estimate the dividends as precisely
as possible in the near future. Okay? Suppose
like in infinities too long we don't know what's
going to happen in 50 years or even in 10
years. So what we can do now is to say at
least in the next five years we have some
good sense about the pattern of the dividends.
So we can just focus our forecasting in the
first of five years. Okay? We say this year like
DZ era we know the farm's dividend is $1. So
we predict in the future the management
probably will maintain the same similar level of
dividends.
So in that sense you see okay in the next five
years I predict the dividend in one year might
just be benchmarked against the year zero of
dividends with some small adjustments say
inflation. So that will give me some number
