Essay about Valuation, Risk and Return

748 Words Nov 1st, 2014 3 Pages
Valuation, Risk, and Return
Five years ago, Laissez-Faire Recliners issued $10,000,000 of corporate bonds with a 30-year maturity. The bonds have a coupon rate of 10.125%, pay interest semiannually, and have a par value of $1,000 per bond. The bonds are currently trading at a price of $879.625 per bond. A 25-year Treasury bond with a 6.825% coupon rate (paid semi-annual) and $1,000 par is currently selling for $975.42. In order to find the yield spread between the corporate bonds and the Treasury bonds we must first find the yields of both bonds. The yield is the amount of return an investor can expect to receive from a bond. The yield for the corporate bond (found using the yield formula in excel) is 11.57%. The yield for the Treasury
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In addition we believe the firm is in a constant state of growth, and our required rate of return for investments at the risk level of 18%. The firm’s common stock is currently trading for $45 per share. If we are looking at whether or not we would purchase these shares or not we must first calculate the return on equity, which is done by net income (1,417,500) by the stockholders’ equity (6,000,000), which gives us a return of equity of 15.5%. This is only accurate when calculating the present value of cash flows method. Another method is the free cash flow method, which we calculate by looking at the year, growth status, growth rate, FCF calculation, FCF and WACC. The growth status is given as constant and the growth rate is given at 15.5%. This makes the FCF calculation of 1.15. The first year FCF is also given as $109,237. In order to calculate the following years FCF we take the first years FCF ($109,237) and multiply it by (1+WACC) the weighted average cost of capital is also given at the appropriate discount rate of 15.83%. Using the before mentioned formula we find that the FCF of year two is $126529.22. If Laissez-Faire’s common stock were to have a more fluctuated growth pater (25% in years 1 through 6, 20% in years 7 through 10, and 15% for years 11 and beyond), the purchase decision would change. This growth is exponentially more profitable to the purchaser and guarantees a more