When considering assigning “value” to a firm’s stock or bond, one method that is considered to be a practical, every day valuation is utilizing the P/E ratio. The P/E ratio, Price-Earnings, is used by taking a multiplier and applying it to current earnings as a way to find the value of shares in the market (Block, Hirt & Danielsen, 2014). To use this valuation, the formula is PO=(P/E)x(Earnings Estimate) (Argosy University Online, 2017) so a company that has a P/E of 30 that is expected to earn $3 a share, has a valuation of $90, which is better than a company that has a P/E of 40 that is expected to earn $2 a share, at $80. This method however, can be influenced by a number of factors including, the earnings and sales growth of the firm, the risk present in the firm’s performance, the debt-equity structure of the firm, the dividend policy, the quality of management, and any number of other factors (Block, Hirt & Danielson, 2014).
Another concept of asset valuation is determining the value of a bond. Block, Hirt & Danielson (2014) states, “A bond provides an annuity stream of interest payments and a $1,000 principal payment at maturity” (p298), assuming that the bond has a PAR value of $1,000. As the valuation of a firm’s financial assets are based on a concept of the present value of future cashflows, the cashflows are then discounted at Y, where Y is the Yield to Maturity (Block, Hirt & Danielson, 2014). The discount for Y is set by the current bond market, and is represented by the required rate of return provided at certain levels of risk and maturity. The easiest way to determine a bond’s value is to utilize a financial calculator, and input the values for N, I/Y, FV, PMT, and calculating for PV. Note that when utilizing a financial calculator, that a plus sign indicates cashflows coming in, and a minus sign indicates cashflows being paid out. So, to find the value of a bond when the
References:
Argosy University Online. (2017) FIN 401: Financial Management. Week 4: Valuing Bonds, Preferred Stock, and Common Stock (7 of 8). Retrieved fromhttps://myclasses.argosy.edu/d2l/le/content/12917/viewContent/411237/View
Block, S., Hirt, G. & Danielsen, B. (2014) Foundations of Financial Management. (15th ed). McGraw-Hill Education. Retrieved from VitalSource Bookshelf.
