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Valuation of Investment Products

University: Nottingham Business School

  • Unit No: 14
  • Level: High school
  • Pages: 8 / Words 2109
  • Paper Type: Assignment
  • Course Code: ACCA40526
  • Downloads: 197
Question :

This sample will let you know about:

  • What is Dividend Discount Model ?
  • Define Bond Valuation.
  • Explain the Concept of modified duration.
Answer :
Organization Selected : Smith Group Plc

INTRODUCTION

Investment products the stocks which are offered to investors by listed organisations. These products are required to be effectively valued so that an informed investment decision can be taken (Bauer and Smeets, 2015). The main aim of this report is to build an understanding about the concept of investment analysis and enhance the skills of using various investment techniques such as share and bond valuation. For this purpose, a large scale listed company is selected which is Smiths Group Plc. This is an engineering company having headquarters in London, United Kingdom. This organisation was founded in 1851 by Samuel Smith. The operations of this company includes few principle divisions which are medical systems, defence and Aerospace.

This report is divided in four parts; the first part will focus upon overview of the selected company including its strengths, weaknesses, opportunities and challenges. The second part of this report is related to share valuation in which selected company’s intrinsic value of share will be computed using various techniques. In the third section of the report, value of the bond of selected company will be estimated using varied interest rate scenarios. In the last section, options of the company will be valued using Black-Scholes Model.    

Company Overview

Smith Group Plc. is a public limited company listed at London Stock Exchange and is a part of FTSE 100 component. This company deals in engineering industry and has competitive image in market. Being a 169 years old organisation, the brand image of this organisation is quite influential. Like every other company, this company also faces challenges due to dynamic market environment. In order to analyse the internal and external environment of this company a framework named SWOT is used below by which strengths, weaknesses, opportunities and threats (challenges) of this company are analysed:

Strengths

Strengths are the internal resources and competencies of an organisation which must be enhanced through effective operations (Bernstrom, 2014). Smith Group Plc has a strong distribution network which easily reaches their potential market is an essential strength of this company. Other strengths of this company includes high level of customer satisfaction, strong brand portfolio and high returns on Capital Expenditure. For the purpose of investment analysis, it must be noted that this company is effective when it comes to gaining high returns of their expenditures which can be beneficial for potential investors.

Weaknesses

This company has comparatively low research and development skills which is a major weakness of this company that must be resolved by investing in R&D department. Another weakness of this company is the non-effective financial planning due to which liquidity of this company gets impacted. This weakness must be considered by its potential investors as they can face the issue of low liquidity if they invest in this company’s stocks.

Opportunities

There are various opportunities which can be grabbed by Smiths Group Plc. The industry in which this company deals is a growing industry which can provide the future opportunity of capturing new customers. This company can also enhance their online platform from which they can reach larger market segments, this opportunity will need investment in big data analytics. Decreasing transportation cost is also an opportunity for this company which can be grabbed by operating in markets which has lower shipping prices (Enever, Isaac and Daley, 2014).

Threats (Challenges)

Threats and challenges are the situations which company has to face while operating in a marketplace. These challenges can affect the productivity and profitability of an organisation. Smith Group Plc. is operating in various markets and facing various challenges. The most influencing challenge for this company is high prices of raw material due to which margin market of this company will be negatively impacted. Other threats or challenges of this company which they may face in future are shortage of skilled employees, intense competition and threats of new entrants in the industry.

Smith Group Plc.’s position in industry

Smith Group Plc. is considered as one of the best organisation working in engineering industry and is a largest provider of security and defence industry. This company holds a strong and competitive position in market. This company faces the threat of new entrant in this industry as continuously innovating new products requires high capital due to which Smith Group Plc. lacks in providing new value proposition to their customers.

The engineering industry is a vast marketplace and includes various sectors. The most important element in such sectors is the raw material which are procured from the suppliers. Due to the dominant position of suppliers in this industry, Smith Group faces the high bargaining power issue from which their margins can also be impacted. But on the other hand, when it comes to the customers, Smith Group Plc. enjoys competitive position in market due to which they can limit the bargain power of their clients. Get Assignment Writing Help from our experts.

The products developed by this company are highly innovative but they are imitable and not rare due to which these products can easily be substituted (Kahn and Lemmon, 2016). This factor implies the submissive position of this company in industry. Smith Group Plc. is operating in an industry where competition is common but then also this group has proven to be the best due to their low margins are competency to create innovative position.

Share Valuation

Dividend Discount Model

This model is a quantitative method of calculating and forecasting the intrinsic value of a share of a company. The intrinsic value is the price of a share which is completely non effected by the external environment. This value is based on only the internal affairs, capabilities and resources of an organisation (Mishra, 2015). To calculate this value, the model of DDM is used in which a principle is used stating that the present day price is the worth of future dividend payments.

Intrinsic value of share for Smiths Group Plc is calculated as 3824.52. This value is computed using the dividend for each year and the combining it with present value factor of 10.27%. This model is considered as most appropriate as it accounts the value of dividend and considers the time value of money.

Earnings and Investments Model

This model considers the earnings of an organisation instead of considering its dividend. In this model, a playout ratio is ascertained which is further factored using discounted method. The intrinsic value of a share can be similar in DDM and this method because in some cases, dividend are the only earnings an organisation has gained.

It can be seen that the intrinsic value of share using EIM method is 3824.52 which is similar with DDM model as Smith Group Plc is distributing all their earnings to their shareholders as dividend.

P/E Multiple

Price earnings model is a financial metric which helps in computing the value of a share by analysing the will of investors which they tend to pay for a share (Neame, 2013).

For the period of six years, earnings per share is ascertained from which the ratio of price earnings is calculated. The intrinsic value of a share of company Smith Group Plc is calculated as 14.03 for the year 2024.

Free Cash Flow Model

This model represents the cash which available to a company after adjusting all the operational expenses and acquisitions of assets. This model is used to calculate the intrinsic value of a share by computing the free cash flow available to the company. In case of Smith Group Plc, there are certain assumptions which are taken stated as cost of debt is 0.39%, tax rate payable by this company is 53.29% and risk free rate is 0.61% which is followed by market risk premium as 9.78%.

From the above numerical analysis, it can be seen that intrinsic value per share is calculated as -18.24. This value is presenting a negative amount which is the result of non availability of free cash flow for Smith Group Plc. 

Critical discussion of the results

Intrinsic value is the measure of calculating worth of a share of an organisation. There are various models by which intrinsic value can be calculated. In context of Smith Group Plc, various models are used (Snowball 2013). The intrinsic value using the dividend discount model and Earnings and Investments Model is similar as dividend are the only earnings which Smith Group Plc is gaining. The reason behind deviation in the intrinsic value computed from different models is the different assumptions which are made. In DDM model, it is assumed that both dividend growth rate and return on equity will be constant forever. On the other hand, free cash flow assumes that there always will be tax rate and risk free rate.

From the implementation of various models, it has been found that potential investors of Smith Group Plc. should use dividend discount model while computing share price of this company. The reason behind this recommendation is that DDM is most suitable model for companies which regularly provide dividend to their shareholders.Need Assignment Samples.Talk to our Experts!

Bond Valuation

Market value of the bond as of 4 February 2020

Market value of a bond is referred as the value at which a bond is traded in market. For the organisation, Smith Group Plc. their bond value on 4 February is calculated below as 101.18.

Investment suitability

In the scenario 1, the interest rate is at 1.0% increase. In this scenario, it is not viable to hold investment as the bond value is 100.92 which is lower than 101.18.

In scenario 2 when there is 0.5% increase, it is not viable to hold the investment as the bond value in this case is 100.97 which is lower than 101.18.

In third scenario, where there is no change in interest rate, it is viable to hold the investment value as the bond value will slightly increase to 101.02.

Similar to scenario 3, it is viable in the scenario where interest rate has decreased to 0.3% as bond value in this case will increase to 101.05.

Calculation of modified duration

The modified duration according to the bond price value of 101.05 is calculated as 6.4116.

Concept of modified duration

Modified duration is the measurable change in the value of a security due to the variation of interest rates. This duration helps an investor to ascertain the value from the price of a security can change due to the variation of its interest rates. It is considered usual that the price of a security such as bond will increase when the interest rate has decreased and vice versa (Stokey, 2016).

There are various issues which are faced while estimating the changes in bond prices using modified duration. It is difficult to calculate the interest rate sensitivity of a security due to which interest rates and yield curve take non parallel shifts and results into incorrect bond value. Get Online Finance Homework Help from our finance experts!

Valuation of Options

  • Price of a 3-month European call option
  • Price of a put option with similar characteristics as the call option
  • Validity of calculations using Put call parity
  • Assumptions in calculation of Put and Call option:
  • Total net profit or loss 

CONCLUSION

As per the above mentioned report, it has been concluded that the investment products offered to investors must be valued effectively so that informed decisions can be made by management regarding investments. calculating and anticipating the internal share value of a firm can be done through dividend discount model. Earning and investment model consider an organization's earnings in which a pay-out ratio is determined which further factored by utilizing discounted model. different types of models help company in determining valuation of investment products in an effective way.

Also Read- Business Expansion- A crucial decision for Organisation


 

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