Valuation Models And Investment Decisions In Finance

Depicting whether it could maintain its superior growth rate for the next 10 years

The overall investment decisions are mainly based on P/E ratio of the company, which could help in growing the overall returns from investment. Therefore, investments needs to be conducted based on the lowest P/E ratio, which allows the investment to grow adequately.

The three factors that are estimated for the valuation modes are depicted as follows.

Expected cash flows:

Bonds cash flow mainly consist of interest rate or the coupon payments along with the principle payments. However, for stocks cash dividends are not expected, where future dividends of the organisation cannot be estimated.

Length of period:

Moreover, stocks are mainly paid annually, where length of the period is not known, as stock is mainly considered perpetual in nature. However, bonds length of the period is mainly depicted in form of daily, monthly, annually, and semi annually coupon payments.

Required rate of return:

Both stocks and bonds required rate of return could not be estimated easily, where the required rate of retune of bonds is mainly depicted from the risk free rate. However, the required rate of return for stocks is mainly derived from security market line, stocks beta and market risk premium (Damodaran, 2016).

The companies whose operations are closely monitored by economic cycle will not be able to provide constant dividends.

Matured companies are mainly faced with slow growth rate in dividends, where organizations are not able to generate the required growth to support its dividend expense. These types of companies use high payout ratio to maintain the dividend growth, which is only conducted for a short duration.

The company who are small and growing are not able to sustain the above average growth rate indefinitely, which could reduce the impact of dividend valuation model.

The three disadvantages of the constant growth dividend model is mainly, depicted as follows.

• The growth dividend model is mainly used by small investors and not be strategic investors at the time of buying the company
• The model is based on the that dividend are constant, which is not possible in real life scenario
• The model mainly fails to perform when growth rate is more than required rate of return. This only indicates that the model mainly assumes that growth rate always needs to be less than required rate of return, which could help in deriving the adequate growth of the shares (Reilly, 2012).

The three alternative methods that are mainly used instead of divined discount model for the valuation of the company are mainly depicted as follow.

• Discounted cash flow method
• Price earnings ratio method
• Net assets value method

If the analysis use the SML method for investment then both Stock B will mainly be used, as Stock A is overvalued, as it has higher beta than the market.

The over DuPont formula mainly consist of three calculations for Return on Equity (ROE). The formula for ROE is depicted as follows.

Therefore, the above table mainly represents the overall ROE formula, which could help in identifying the overall return on investment of equity.

It is mainly depicted that if the problem of the organization is not persistent then the management could accumulate the required resource in anticipation of future growth. Moreover, there are four different alternatives types of measures, which could be considered by the organisation when actual growth falls below sustainable growth are depicted as follows.

• Acquiring another company or investment in another company by conducting mergers
• Relatively increasing the overall amount of dividend or dividend payout ratio
• Moreover, the company could also initiate share buyback, which would allow the organisation to return money to the shareholders.
• Furthermore, the company could also reduce its liabilities, which would decrease pay off debts and decline the leverage.

The overall valuation of the goodwill, interest expense, and income taxes of the organisation is relatively higher, which could directly affect sustainable growth of the organisation. Therefore, seeing the overall evaluation Turk is encouraging Francesca Toy to take adequate sustainable growth, where actual growth rate exceeds actual growth rate.

Reference:

Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

Reilly, F. K. (2012). Investment Analysis and Portfolio Management, 10th Edition. [Strayer University Bookshelf]. Retrieved from https://strayer.vitalsource.com/#/books/9781305561687/