Please respond to discussion board 4 & 5 question that is shown after the discussion board rubric/requirements. Please do not copy/paste from sources. Write in own words and cite where it came from. No more than 500 or so words per discussion board. Thank You

Discussion Rubric Critical Thinking Skills Content/Subject Knowledge Demonstrated in Original Post Student's post indicates thoughtful analysis and provides valuable insight into the topic. Student thoroughly addresses all elements of the discussion prompt, and demonstrates an advanced knowledge of the topic. Student makes strong and precise connections to previous and/or current course content, or to real-life situations, in initial post Participation Student responds with thorough and constructive analysis to the required number of peers, relating the response to relevant course concepts. Student may pose pertinent follow-up thoughts or questions about the topic, and demonstrates respect for the diverse opinions of fellow learners. Coherence & Organization Student effectively communicates a central idea or point that is weaved throughout the entirety of the post, in a coherent and logical manner. Post is easy to understand. Mechanics Initial post contains very few, if any, minor errors related to grammar, spelling, and sentence structure. Post is easy to read and understand. Student properly cites resources. Student does not copy/paste sources. Discussion Boards Week 4 "Risk and Return" Please respond to the following: From the e-Activity, determine whether stock prices are affected more by long-term or short-term performance. Provide one (1) example of the effect that supports your claim. From the scenario, value a share of TFC's stock using a growth model method and compare that value to the current trading price of a share of TFC. Determine whether the stock is undervalued or overvalued. Provide a rationale for your response. Week 5 "Financial Options and Weighted Average Cost of Capital (WACC)" Please respond to the following: Determine two to three (2-3) methods of using stocks and options to create a risk-free hedge portfolio can be created. Support your answer with examples of these methods being used to create a risk-free hedge portfolio. From the scenario, create a unique hypothetical weighted average cost of capital (WACC) and rate of return. Recommend whether or not the company should expand, and defend your position. Classmates Discussion Board Post Week 4 Discussion From the e-Activity, determine whether stock prices are affected more by long-term or short-term performance. Provide one (1) example of the effect that supports your claim. Stock costs will be influenced more by attempting to increase long haul money streams than by concentrating on fleeting streams. A large portion of a stock's worth is because of long haul money streams yet being mindful to quarterly income are critical. For instance, when genuine quarterly profit are lower than anticipated not as a result of principal issues but rather in light of the fact that an organization has increased its innovative work uses, concentrates on have demonstrated that the stock cost most likely won't decrease and may really increase. This will be conceivable on the grounds that innovative work ought to increase future money streams (Brigham, 2014, pg. 299). Then again, if quarterly profit are lower than anticipated because of client's aversion of the organization's new items, then this new data will have negative ramifications for future estimations of g (the long haul development rate). Little changes in g can prompt extensive changes in stock costs. Albeit fleeting quarterly profit themselves may not add to an extensive part to a stock's value, the data that they pass on about future prospects are critical. Brigham, E. F., & Ehrhardt, M. C. (2014). Financial management (14th ed.). Mason, OH: South-Western Cengage Learning. From the scenario, value a share of TFC's stock using a growth model method and compare that value to the current trading price of a share of TFC. Determine whether the stock is undervalued or overvalued. Provide a rationale for your response. As indicated by the situation, utilizing the examination of the present development model for the required rate of return and the normal rate of return, we were inquired as to whether we could give the financial specialists a 15% return CAPM. We utilized beta as an expected number which gave us a benchmark. TFC needed to know the estimation of their stock and remember organization changes. We utilized the steady development model to decide the offer cost. We were given present estimation of all future money streams, the variables given were:Dividends flat rate $10.00Growth Rate (g) 10% Required Rate on Return 15% Using the Constant Growth Model : (10*(1+.10)) / (.15 - .10) = $220 The calculated result = $220.00 per share of stock Compare to the days current trading $220.65 To determine if stock value is undervalued or overvalued we use CAPM= Rf + B(Rm-Rf) =3% + 0.8(15%-3%)= .126 or 12.6 Therefore, It is UNDERVALUED. Wallet, N., (2013). NerdWallet Analysis: How Much Do Short Term Earnings Really Impact Stock Prices? Retrieved January 28, 2015, from http://www.nerdwallet.com/blog/investing/2013erdwallet-analysis-shortterm-earnings-impact-stock-prices/ FIN534 Week 4 Scenario Script: The CAPM and Market Efficiency and Valuing Common Stocks Slide Scene/Interaction Narration # Slide 1 Scene 1 Slide 2 Scene 2 Slide 3 Opening slide Don and Linda in Parking Lot Before Work Show Strayer banner End of scene Scene 3 Don and Linda in front of TFC Go to next slide FIN534_4_2_Don-1: I see you are here bright and early as usual. You and your intern have been doing fabulous work. We are looking for someone like your intern to come on board, but I would like to see your intern work on some more projects before we consider extending an offer. FIN534_4_2_Linda-1: Of course, I understand Don. So far, our intern has done excellent work. Strayer University is really teaching its students well. Our intern has seemingly learned the concepts taught in class and has been able to apply here on the job. FIN534_4_3_Linda-1: Don, you mentioned some more work? FIN534_4_3_Don-1: Yes, Linda. Since TFC went public, we have always considered our stockholder risk averse, as they want to see their investment grow but without a lot of risk. Based on the ratio analysis you showed me, it seems we have been doing just that. However, this expansion project is not revealing the same picture. When Joe talks to our investors, he wants to be able to explain why this project is good for TFC's future even though financially, it may not seem like the best move. With that, I would like you and your intern to come up with the expected rate of return that our investors are currently benefiting from their equity. This will also be our required rate of return for the project, as we have to give the investors a return on their investment. Slide 4 Slide 5 Scene 4 Linda In conference room Show CAPM acronym Equation on slide TFC's Required Rate of Return = Risk-free rate + Risk premium Go to next slide Scene 5 In conference room List components and equation RTFC = r + betaTFC x RPM Linda discusses the variables RF Go to next slide FIN534_4_3_Linda-2: Sounds great Don. Let's go inside. I am going to meet the intern in the conference room to discuss our next project. FIN534_4_4_Linda-1: I just met with Don and he has given us another project. He asked that we calculate TFC's expected rate of return, which is also the required rate of return for our stockholders. In order to do that we are going to use the Capital Asset Pricing Model, or CAPM. With the help of the Security Market Line, or SML, we will use inputs to calculate the required rate of return. In general the required rate of return for TFC will be a risk-free rate plus some additional market premiums. When we put it all together, we will come up with our required rate of return. FIN534_4_4_Linda-2: Our formula can be thought of as the required rate of return for TFC is equal to the risk-free rate plus a risk premium for TFC's stock. FIN534_4_5_Linda-1: In order for us to calculate the required rate of return, let's go over all the components of the calculation. FIN534_4_5_Linda-2: First, let's look at the Risk-free rate. This is simply the rate on riskless securities and is commonly measured by the yield on long term U.S. Treasury bonds. It is based in the understanding that the U.S. government will not default on their obligations so the bonds are considered risk free. FIN534_4_5_Linda-3: Next is the Market Risk Premium, or RP sub M. The Market Risk Premium can be thought of as the additional risk that comes with investing in a nongovernment security. This is that extra risk premium that is put on any security that is above the risk-free rate. From an investor's standpoint, they want a premium on any investment that is not risk-free because they will be assuming the risk and the trade off is the higher the risk, the higher the return demanded. The RP sub M is the difference between what the market is returning and the risk free rate. Slide 6 Scene 6 Still in conference room with paper on table Linda makes a phone call (get sound effect of phone dialing) Go to next slide FIN534_4_5_Linda-4: And lastly is Beta, which is a measure of how much TFC's risk would contribute to a well diversified portfolio. Typically stocks have a beta between zero point four and zero point six. FIN534_4_6_Linda-1: Now that we have our variables, let us determine what the expected value is. Before we do that, we need to call the Accounting Department to get some numbers from them, such as the beta for TFC and the risk free and market rates. (Linda makes a phone call) FIN534_4_6_Linda-2: This is Linda who is working on the expansion project and we would like to know the long-term U.S. Treasury bond rate, market portfolio rate, and TFC's beta. (Pause) Thank you. (Linda hangs up) FIN534_4_6_Linda-3: (makes a quick laugh) It is something how once you mention the expansion project everyone stops what they are doing and gives you what you need. FIN534_4_6_Linda-4: Accounting said that the long term bond rate is three percent, the market rate is eighteen percent and TFC's calculated beta is point eight. FIN534_4_6_Linda-5: I am going to the Accounting Department to personally thank them. While I am gone, can you calculate the required rate of return based on this data? Slide 7 Scene 7 Check Your Understanding: Calculate Rates here Can we have student slide scenario to dollar amount? Go to next slide (1) Linda would like you to calculate the required rate of return for TFC's stock given that the long term bond rate is three percent, the market rate is eighteen percent and TFC's calculated beta is point 8. Student calculates rate here and other scenarios. (2) What would happen if the beta would change to .6 (point 6) and all other values are the same? (3) What would happen if the U.S. long term bond rate was 2% and all other values are the same? (1) Correct Answer = 15%. If get wrong: Nice try To calculate the CAPM you need to use the formula RTFC = r + betaTFC x RPM RF When the risk free rate is .03, market rate is .18 and beta is .8 (2)Correct Answer = 12% If get wrong: Nice try To calculate the CAPM you need to use the formula RTFC = r + betaTFC x RPM RF When the risk free rate is .03, market rate is .18 and beta is .6 (3)Correct Answer = 14.80% If get wrong: Nice try, but remember to calculate the CAPM you need to use the formula RTFC = r + betaTFC x RPM RF When the risk free rate is .02, market rate is .18 and beta is .8 Slide 8 Scene 8 Move into Linda's office Next slide FIN534_4_8_Linda-1: Great work! Your calculations show that TFC's required rate of return is fifteen percent, which is also the expected rate of return that investors want. Our investors have been really good to us so it is nice that we are giving them a strong return. The issue is..., can we give them that desired return? As we saw with our financial analysis, this project will really affect our cash basis, so a lot of analysis is needed before rendering a decision. FIN534_4_8_Linda-2: Also, keep in mind that the CAPM is not perfect. For example, Beta is an estimated number and there can be changes in rates. However, this measurement gives us a benchmark based on the available information. (Phone rings - Don on the line) FIN534_4_8_Linda-3: Hello Don. We calculated fifteen percent for the required rate of return. (Pause) Yes, it was the intern who did the terrific analysis. (Pause) Another request? Sure what would you like us to do? (A few seconds go by.......) Okay we will get right on it FIN534_4_8_Linda-4: Don would like us to go further with this work and calculate TFC's stock price. This is the internal price which may be different from what the market price of TFC's stock price. Slide 9 Scene 9 - Don and Linda in room Don is on his way to the conference room to further explain what he needs. FIN534_4_9_Don-1: Hello again. The required rate of return you calculated is very important to us as it tells what our shareholders can expect to receive as a return on their investment. Using this rate, we can also determine what we feel is TFC's value per share of stock. If we are going to stay competitive in the fitness center industry, we have to make sure our price is valued as it should. There are many ways to value stock. We have decided to use the Constant Growth Model. Note that we have not valued our stock yet because we did not have a required rate of return. Thanks to your hard work we now have that rate and will be using it in the Constant Growth Model. FIN534_4_9_Linda-1: Don, you are so right about not valuing our stock. We always have done our business work on a small scale, but since we may be undertaking this big expansion project, we have also decided to revise our business practices. So not only are we reviewing the financial side of the expansion project, we are also reviewing what we are doing as a business in regard to administration. This expansion project will only make TFC stronger. Slide 10 Scene 10 Don and Linda in conference room, different part of room Put factors on screen - roll them out Stock Price (Psub0) = Dsub 0 times (1 plus dividend rate) all divided by (rate of return minus the dividend rate) Next screen FIN534_4_9_Don-2: You are correct Linda. We want to become stronger all around. But first, we need to look at the value of TFC. Let us look at some of the variables for determining the share price. FIN534_4_10_Don-1: As I mentioned before, the Constant Growth Model is the preferred choice for valuing our stock. There are many ways to value a stock but we have chosen this model because of a number of factors. The key to this valuation process is to understand that the value of TFC will be found by taking the present value of all future cash flows. FIN534_4_10_Don-2: Our first factor for choosing this method centers on dividends. Over the years we have been kind to our investors by providing a flat ten dollar dividend amount. In the financial world this variable is usually labeled D sub zero. FIN534_4_10_Don-3: Our second factor is our growth rate, signified by \"g\". This is the rate that we expect dividends to grow. It has been decided that since we are undertaking this big expansion project and considering how loyal our investors have been to us, it is time to increase the dividend rate. We plan to have dividends grow at the rate of ten percent each year. Again, we feel that keeping a strong shareholder base is important. The increase in dividends will enable investors to receive a constant return on their investment. FIN534_4_10_Don-4: Our third factor has already been completed by you and it is the required rate of return, which you calculated to be fifteen percent. FIN534_4_10_Don-5: Using the Constant Growth Model, the formula of stock value for TFC equals dividend today times one plus the growth rate all divided by the required rate of return minus the growth rate. FIN534_4_10_Linda-1: Thanks, Don. I think this is a good formula for our intern to use. Slide 11 Scene 11 CYU Next Slide Using all the information that you calculated and what Don said, what is the value of TFCs stock as of today? Correct answer is $220. Great job. Using the Constant Growth Model you would use the dividend in year one divided by the required rate of return minus the growth rate Slide 12 Incorrect - Nice try. Using the Constant Growth Model you would take Dividends in year one, which is $11 ($10*(1 + .10) and divide that by (.15-.10) or .05 Scene 12 Show stock market on TV or reports on market in conference room FIN534_4_12_Linda-1: Great job as always. Two hundred and twenty dollars is what the value of TFC's stock should be at today. Don, do you have the most recent trading information on TFCs stock price as of today? FIN534_4_12_Don-1: Yes. You know I always have my electronic devices tuned into the stock market. As of now, TFC is trading at two hundred twenty dollars and sixty five cents. I guess you can say we are efficient! (they all laugh) Slide 13 Scene 13 Check Your Understanding - Have student calculate the Price of a share of stock for TFC From the information given below, what would the stock price be for TFC based on the following information? (Justin can you give choices here for them? 1) Dividend today = $10; Growth Rate = 12%; Required Rate of Return = 15% Answer = $373.33 2) Dividend today = $10; Growth Rate = 0%; Required Rate of Return = 15% Answer = $66.67 3) Dividend today = $10; Growth Rate = 8%; Required Rate of Return = 15% Answer = $154.29 Incorrect Feedback: Remember the Constant Growth Model formula is equal to Today's Dividend times (1 + Growth Rate) all divided by (Required Rate of Return - Growth Rate) Slide 14 Scene 14 Slide 15 FIN534_4_14_Linda-1: Great work again. As you can see, with all else constant the growth Linda Speaks about how rate can really affect the price of a share of growth rate affects stock price stock. That is why it was important for TFC to establish a dividend growth rate. Also, when Linda moves to another spot the stock price calculated is compared to the market price, decisions can be made as to Next Slide whether or not they are undervalued or overvalued. Scene 15 Summary Slide - CAPM and Valuing Stocks FIN534_4_14_Linda-2: Besides the Constant Growth Model, there are other valuation models, but in many of the instances they all are about cash flows. Here we are concerned about cash as that can be the driving force for many business decisions. FIN534_4_15_Linda-1: This project took us to a different area of our company. We calculated a required rate which can also be thought of as the expected return for our investors. We reviewed how a situational analysis can provide different results and can be used during the decision making process. After the required rate of return calculation, we then calculated TFC's share price under the Constant Growth Model. We again did some situational analyses to see how input changes can really affect business decisions. That is why it is so important to do a thorough analysis before accepting or rejecting a project. And that is exactly what we are doing with the TFC expansion project. I wonder what our next project will be. FIN534_4_15_Linda-2: Time for exercise! Let's go to the gym. Slide 16 Scene 16 Closing slide Reminder about weekly discussions. Closing slide Week 4 Discussion Part I There will be an equal effect on the price of the stock with respect to both short-term and long-term performance. Since the companies are well aware that the change in the price of the stock will depend on the sentiments of the investors pertaining to the decisions of the management. So the companies are vigilant with respect to the revelation of information to the stockholders. The companies foresee in advance the effect of their management decisions on sentiments of investors. They take due care before revealing the information to the public. For example, in case if the company makes a new acquisition of one of its competitors in order to make position of its company more strong, it can release the report pertaining to current growth rate before making public the information of its acquisition. Contrary to it, if the company plans to discontinue any of its products or to discontinue any area of its operations or to close any of its business segments, it may wait for the ending of the quarter. The company will wait for ending of the quarter and will make the information public after releasing its quarterly reports. There are a number of factors by which the price of the stock of the company is affected in long term as well as in short term. Long term decisions are influenced by major events such as change in market demand or market supply and purchase price parity due to which the market value of the stock decreases. Short term movement in the price of the stock is influenced by various events, news, etc. Part II Gordon growth model is used to evaluate the intrinsic value of the stock. It determines whether the stock in overvalued or undervalued by comparing the stock with its intrinsic value. It is considered that the intrinsic value is the true and actual value of a stock as it eliminates the impact and perceptions of all the market forces. It performs the calculations that are based on the dividend paying capacity of the company or on the results that is expected by the shareholder's on the investment that they make in shares of the company. If the intrinsic value of the stock is higher than the current market price of the stock the stock will be treated as undervalued. Contrary to it if the intrinsic value of the stock is lower than the current market price of the stock then the stock will be treated as overvalued. Following are the variables that are required to calculate the intrinsic value of the stock of TFC: Required Rate on Return = 15% Flat dividend rate = $10.00 Growth Rate (g) = 10% Substituting the values in Constant Growth Model = (10*(1+.10)) / (.15 - .10) = $220 Intrinsic value of the stock = $220.00 per share Since the current trading price of stock is higher by $0.65 ($220.65 - $220.65) it is apparent that the stock is marginally overvalued. In present scenario the stock shall trade below $220. In case if the company does not pays dividends according to the expectations of shareholders, the stock may see a fall in its market value. Week 5 Discussion Part I Hedging is a tool that is used by the investors to lower their risk that they may sustain due to fluctuation in the price of commodity, exchange rates or the interest rates (Brigham, E. F., & Ehrhardt, M. C. 2014). It is a method of minimizing or transferring risk. It is used as a strategy to protect oneself from the prevailing uncertainties. A risk-free portfolio of stock and options can be created using hedging. The two methods of hedging are discussed below: Call Option Method Under this method a risk-free hedge portfolio is created through call options. Call option is an arrangement in which the investor gets a right for buying stock or bond at a definite price and also within a definite time. In case if the price of the call increased the profit is booked by the investor. It gives an opportunity to the investor to leverage their money for higher return on investment. Put Option Method Under this method a risk-free hedge portfolio is created by using put options. It is an option contract that gives the right to the investor for selling stock or bond at a definite price and also within a definite time. Call option provides risk-free hedging for buying the stocks or bonds whereas put option provides for selling the stock or bonds. In case of decline in the price of the security the profit is booked by the investor by purchasing the security. It provides an opportunity to investors to speculate an investment they do not own or to hedge an investment they own. Part II Following hypothetical figures have been assumed for the purpose of calculating WACC. E = Company' Equity = $1,200,000 D = Company's Debts = $800,000 V = Total Equity and Debts = $2,000,000 Re = Cost of Equity = 0.06 Rd = Cost of Debt = 0.05 T = Tax Rate = 35% The Formula for Weighted Average Cost of Capital is: WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)] Substituting values in formula we get: WACC = ((1200000/2000000)*0.06)+(((800000/2000000)*0.05)*(1-0.35)) = 0.049 or 49% The weighted average cost of capital (WACC) of the company is 4.9%. It means that for each dollar of the funds that the company raises from its investors, the company must pay $0.05 in return. The remaining 0.95 can be used by the company for its business or for purchasing assets. The WACC of the company is low so it is suggested that the company should expand it. References Brigham, E. F., & Ehrhardt, M. C. (2014). Financial management (14th ed.). Mason, OH: SouthWestern Cengage Learning. Classmates Discussion Board Post Week 4 Discussion From the e-Activity, determine whether stock prices are affected more by long-term or short-term performance. Provide one (1) example of the effect that supports your claim. Stock costs will be influenced more by attempting to increase long haul money streams than by concentrating on fleeting streams. A large portion of a stock's worth is because of long haul money streams yet being mindful to quarterly income are critical. For instance, when genuine quarterly profit are lower than anticipated not as a result of principal issues but rather in light of the fact that an organization has increased its innovative work uses, concentrates on have demonstrated that the stock cost most likely won't decrease and may really increase. This will be conceivable on the grounds that innovative work ought to increase future money streams (Brigham, 2014, pg. 299). Then again, if quarterly profit are lower than anticipated because of client's aversion of the organization's new items, then this new data will have negative ramifications for future estimations of g (the long haul development rate). Little changes in g can prompt extensive changes in stock costs. Albeit fleeting quarterly profit themselves may not add to an extensive part to a stock's value, the data that they pass on about future prospects are critical. Brigham, E. F., & Ehrhardt, M. C. (2014). Financial management (14th ed.). Mason, OH: South-Western Cengage Learning. From the scenario, value a share of TFC's stock using a growth model method and compare that value to the current trading price of a share of TFC. Determine whether the stock is undervalued or overvalued. Provide a rationale for your response. As indicated by the situation, utilizing the examination of the present development model for the required rate of return and the normal rate of return, we were inquired as to whether we could give the financial specialists a 15% return CAPM. We utilized beta as an expected number which gave us a benchmark. TFC needed to know the estimation of their stock and remember organization changes. We utilized the steady development model to decide the offer cost. We were given present estimation of all future money streams, the variables given were:Dividends flat rate $10.00Growth Rate (g) 10% Required Rate on Return 15% Using the Constant Growth Model : (10*(1+.10)) / (.15 - .10) = $220 The calculated result = $220.00 per share of stock Compare to the days current trading $220.65 To determine if stock value is undervalued or overvalued we use CAPM= Rf + B(Rm-Rf) =3% + 0.8(15%-3%)= .126 or 12.6 Therefore, It is UNDERVALUED. Wallet, N., (2013). NerdWallet Analysis: How Much Do Short Term Earnings Really Impact Stock Prices? Retrieved January 28, 2015, from http://www.nerdwallet.com/blog/investing/2013erdwallet-analysis-shortterm-earnings-impact-stock-prices/ FIN534 Week 4 Scenario Script: The CAPM and Market Efficiency and Valuing Common Stocks Slide Scene/Interaction Narration # Slide 1 Scene 1 Slide 2 Scene 2 Slide 3 Opening slide Don and Linda in Parking Lot Before Work Show Strayer banner End of scene Scene 3 Don and Linda in front of TFC Go to next slide FIN534_4_2_Don-1: I see you are here bright and early as usual. You and your intern have been doing fabulous work. We are looking for someone like your intern to come on board, but I would like to see your intern work on some more projects before we consider extending an offer. FIN534_4_2_Linda-1: Of course, I understand Don. So far, our intern has done excellent work. Strayer University is really teaching its students well. Our intern has seemingly learned the concepts taught in class and has been able to apply here on the job. FIN534_4_3_Linda-1: Don, you mentioned some more work? FIN534_4_3_Don-1: Yes, Linda. Since TFC went public, we have always considered our stockholder risk averse, as they want to see their investment grow but without a lot of risk. Based on the ratio analysis you showed me, it seems we have been doing just that. However, this expansion project is not revealing the same picture. When Joe talks to our investors, he wants to be able to explain why this project is good for TFC's future even though financially, it may not seem like the best move. With that, I would like you and your intern to come up with the expected rate of return that our investors are currently benefiting from their equity. This will also be our required rate of return for the project, as we have to give the investors a return on their investment. Slide 4 Slide 5 Scene 4 Linda In conference room Show CAPM acronym Equation on slide TFC's Required Rate of Return = Risk-free rate + Risk premium Go to next slide Scene 5 In conference room List components and equation RTFC = r + betaTFC x RPM Linda discusses the variables RF Go to next slide FIN534_4_3_Linda-2: Sounds great Don. Let's go inside. I am going to meet the intern in the conference room to discuss our next project. FIN534_4_4_Linda-1: I just met with Don and he has given us another project. He asked that we calculate TFC's expected rate of return, which is also the required rate of return for our stockholders. In order to do that we are going to use the Capital Asset Pricing Model, or CAPM. With the help of the Security Market Line, or SML, we will use inputs to calculate the required rate of return. In general the required rate of return for TFC will be a risk-free rate plus some additional market premiums. When we put it all together, we will come up with our required rate of return. FIN534_4_4_Linda-2: Our formula can be thought of as the required rate of return for TFC is equal to the risk-free rate plus a risk premium for TFC's stock. FIN534_4_5_Linda-1: In order for us to calculate the required rate of return, let's go over all the components of the calculation. FIN534_4_5_Linda-2: First, let's look at the Risk-free rate. This is simply the rate on riskless securities and is commonly measured by the yield on long term U.S. Treasury bonds. It is based in the understanding that the U.S. government will not default on their obligations so the bonds are considered risk free. FIN534_4_5_Linda-3: Next is the Market Risk Premium, or RP sub M. The Market Risk Premium can be thought of as the additional risk that comes with investing in a nongovernment security. This is that extra risk premium that is put on any security that is above the risk-free rate. From an investor's standpoint, they want a premium on any investment that is not risk-free because they will be assuming the risk and the trade off is the higher the risk, the higher the return demanded. The RP sub M is the difference between what the market is returning and the risk free rate. Slide 6 Scene 6 Still in conference room with paper on table Linda makes a phone call (get sound effect of phone dialing) Go to next slide FIN534_4_5_Linda-4: And lastly is Beta, which is a measure of how much TFC's risk would contribute to a well diversified portfolio. Typically stocks have a beta between zero point four and zero point six. FIN534_4_6_Linda-1: Now that we have our variables, let us determine what the expected value is. Before we do that, we need to call the Accounting Department to get some numbers from them, such as the beta for TFC and the risk free and market rates. (Linda makes a phone call) FIN534_4_6_Linda-2: This is Linda who is working on the expansion project and we would like to know the long-term U.S. Treasury bond rate, market portfolio rate, and TFC's beta. (Pause) Thank you. (Linda hangs up) FIN534_4_6_Linda-3: (makes a quick laugh) It is something how once you mention the expansion project everyone stops what they are doing and gives you what you need. FIN534_4_6_Linda-4: Accounting said that the long term bond rate is three percent, the market rate is eighteen percent and TFC's calculated beta is point eight. FIN534_4_6_Linda-5: I am going to the Accounting Department to personally thank them. While I am gone, can you calculate the required rate of return based on this data? Slide 7 Scene 7 Check Your Understanding: Calculate Rates here Can we have student slide scenario to dollar amount? Go to next slide (1) Linda would like you to calculate the required rate of return for TFC's stock given that the long term bond rate is three percent, the market rate is eighteen percent and TFC's calculated beta is point 8. Student calculates rate here and other scenarios. (2) What would happen if the beta would change to .6 (point 6) and all other values are the same? (3) What would happen if the U.S. long term bond rate was 2% and all other values are the same? (1) Correct Answer = 15%. If get wrong: Nice try To calculate the CAPM you need to use the formula RTFC = r + betaTFC x RPM RF When the risk free rate is .03, market rate is .18 and beta is .8 (2)Correct Answer = 12% If get wrong: Nice try To calculate the CAPM you need to use the formula RTFC = r + betaTFC x RPM RF When the risk free rate is .03, market rate is .18 and beta is .6 (3)Correct Answer = 14.80% If get wrong: Nice try, but remember to calculate the CAPM you need to use the formula RTFC = r + betaTFC x RPM RF When the risk free rate is .02, market rate is .18 and beta is .8 Slide 8 Scene 8 Move into Linda's office Next slide FIN534_4_8_Linda-1: Great work! Your calculations show that TFC's required rate of return is fifteen percent, which is also the expected rate of return that investors want. Our investors have been really good to us so it is nice that we are giving them a strong return. The issue is..., can we give them that desired return? As we saw with our financial analysis, this project will really affect our cash basis, so a lot of analysis is needed before rendering a decision. FIN534_4_8_Linda-2: Also, keep in mind that the CAPM is not perfect. For example, Beta is an estimated number and there can be changes in rates. However, this measurement gives us a benchmark based on the available information. (Phone rings - Don on the line) FIN534_4_8_Linda-3: Hello Don. We calculated fifteen percent for the required rate of return. (Pause) Yes, it was the intern who did the terrific analysis. (Pause) Another request? Sure what would you like us to do? (A few seconds go by.......) Okay we will get right on it FIN534_4_8_Linda-4: Don would like us to go further with this work and calculate TFC's stock price. This is the internal price which may be different from what the market price of TFC's stock price. Slide 9 Scene 9 - Don and Linda in room Don is on his way to the conference room to further explain what he needs. FIN534_4_9_Don-1: Hello again. The required rate of return you calculated is very important to us as it tells what our shareholders can expect to receive as a return on their investment. Using this rate, we can also determine what we feel is TFC's value per share of stock. If we are going to stay competitive in the fitness center industry, we have to make sure our price is valued as it should. There are many ways to value stock. We have decided to use the Constant Growth Model. Note that we have not valued our stock yet because we did not have a required rate of return. Thanks to your hard work we now have that rate and will be using it in the Constant Growth Model. FIN534_4_9_Linda-1: Don, you are so right about not valuing our stock. We always have done our business work on a small scale, but since we may be undertaking this big expansion project, we have also decided to revise our business practices. So not only are we reviewing the financial side of the expansion project, we are also reviewing what we are doing as a business in regard to administration. This expansion project will only make TFC stronger. Slide 10 Scene 10 Don and Linda in conference room, different part of room Put factors on screen - roll them out Stock Price (Psub0) = Dsub 0 times (1 plus dividend rate) all divided by (rate of return minus the dividend rate) Next screen FIN534_4_9_Don-2: You are correct Linda. We want to become stronger all around. But first, we need to look at the value of TFC. Let us look at some of the variables for determining the share price. FIN534_4_10_Don-1: As I mentioned before, the Constant Growth Model is the preferred choice for valuing our stock. There are many ways to value a stock but we have chosen this model because of a number of factors. The key to this valuation process is to understand that the value of TFC will be found by taking the present value of all future cash flows. FIN534_4_10_Don-2: Our first factor for choosing this method centers on dividends. Over the years we have been kind to our investors by providing a flat ten dollar dividend amount. In the financial world this variable is usually labeled D sub zero. FIN534_4_10_Don-3: Our second factor is our growth rate, signified by \"g\". This is the rate that we expect dividends to grow. It has been decided that since we are undertaking this big expansion project and considering how loyal our investors have been to us, it is time to increase the dividend rate. We plan to have dividends grow at the rate of ten percent each year. Again, we feel that keeping a strong shareholder base is important. The increase in dividends will enable investors to receive a constant return on their investment. FIN534_4_10_Don-4: Our third factor has already been completed by you and it is the required rate of return, which you calculated to be fifteen percent. FIN534_4_10_Don-5: Using the Constant Growth Model, the formula of stock value for TFC equals dividend today times one plus the growth rate all divided by the required rate of return minus the growth rate. FIN534_4_10_Linda-1: Thanks, Don. I think this is a good formula for our intern to use. Slide 11 Scene 11 CYU Next Slide Using all the information that you calculated and what Don said, what is the value of TFCs stock as of today? Correct answer is $220. Great job. Using the Constant Growth Model you would use the dividend in year one divided by the required rate of return minus the growth rate Slide 12 Incorrect - Nice try. Using the Constant Growth Model you would take Dividends in year one, which is $11 ($10*(1 + .10) and divide that by (.15-.10) or .05 Scene 12 Show stock market on TV or reports on market in conference room FIN534_4_12_Linda-1: Great job as always. Two hundred and twenty dollars is what the value of TFC's stock should be at today. Don, do you have the most recent trading information on TFCs stock price as of today? FIN534_4_12_Don-1: Yes. You know I always have my electronic devices tuned into the stock market. As of now, TFC is trading at two hundred twenty dollars and sixty five cents. I guess you can say we are efficient! (they all laugh) Slide 13 Scene 13 Check Your Understanding - Have student calculate the Price of a share of stock for TFC From the information given below, what would the stock price be for TFC based on the following information? (Justin can you give choices here for them? 1) Dividend today = $10; Growth Rate = 12%; Required Rate of Return = 15% Answer = $373.33 2) Dividend today = $10; Growth Rate = 0%; Required Rate of Return = 15% Answer = $66.67 3) Dividend today = $10; Growth Rate = 8%; Required Rate of Return = 15% Answer = $154.29 Incorrect Feedback: Remember the Constant Growth Model formula is equal to Today's Dividend times (1 + Growth Rate) all divided by (Required Rate of Return - Growth Rate) Slide 14 Scene 14 Slide 15 FIN534_4_14_Linda-1: Great work again. As you can see, with all else constant the growth Linda Speaks about how rate can really affect the price of a share of growth rate affects stock price stock. That is why it was important for TFC to establish a dividend growth rate. Also, when Linda moves to another spot the stock price calculated is compared to the market price, decisions can be made as to Next Slide whether or not they are undervalued or overvalued. Scene 15 Summary Slide - CAPM and Valuing Stocks FIN534_4_14_Linda-2: Besides the Constant Growth Model, there are other valuation models, but in many of the instances they all are about cash flows. Here we are concerned about cash as that can be the driving force for many business decisions. FIN534_4_15_Linda-1: This project took us to a different area of our company. We calculated a required rate which can also be thought of as the expected return for our investors. We reviewed how a situational analysis can provide different results and can be used during the decision making process. After the required rate of return calculation, we then calculated TFC's share price under the Constant Growth Model. We again did some situational analyses to see how input changes can really affect business decisions. That is why it is so important to do a thorough analysis before accepting or rejecting a project. And that is exactly what we are doing with the TFC expansion project. I wonder what our next project will be. FIN534_4_15_Linda-2: Time for exercise! Let's go to the gym. Slide 16 Scene 16 Closing slide Reminder about weekly discussions. Closing slide Week 4 Discussion Part I There will be an equal effect on the price of the stock with respect to both short-term and long-term performance. Since the companies are well aware that the change in the price of the stock will depend on the sentiments of the investors pertaining to the decisions of the management. So the companies are vigilant with respect to the revelation of information to the stockholders. The companies foresee in advance the effect of their management decisions on sentiments of investors. They take due care before revealing the information to the public. For example, in case if the company makes a new acquisition of one of its competitors in order to make position of its company more strong, it can release the report pertaining to current growth rate before making public the information of its acquisition. Contrary to it, if the company plans to discontinue any of its products or to discontinue any area of its operations or to close any of its business segments, it may wait for the ending of the quarter. The company will wait for ending of the quarter and will make the information public after releasing its quarterly reports. There are a number of factors by which the price of the stock of the company is affected in long term as well as in short term. Long term decisions are influenced by major events such as change in market demand or market supply and purchase price parity due to which the market value of the stock decreases. Short term movement in the price of the stock is influenced by various events, news, etc. Part II Gordon growth model is used to evaluate the intrinsic value of the stock. It determines whether the stock in overvalued or undervalued by comparing the stock with its intrinsic value. It is considered that the intrinsic value is the true and actual value of a stock as it eliminates the impact and perceptions of all the market forces. It performs the calculations that are based on the dividend paying capacity of the company or on the results that is expected by the shareholder's on the investment that they make in shares of the company. If the intrinsic value of the stock is higher than the current market price of the stock the stock will be treated as undervalued. Contrary to it if the intrinsic value of the stock is lower than the current market price of the stock then the stock will be treated as overvalued. Following are the variables that are required to calculate the intrinsic value of the stock of TFC: Required Rate on Return = 15% Flat dividend rate = $10.00 Growth Rate (g) = 10% Substituting the values in Constant Growth Model = (10*(1+.10)) / (.15 - .10) = $220 Intrinsic value of the stock = $220.00 per share Since the current trading price of stock is higher by $0.65 ($220.65 - $220.65) it is apparent that the stock is marginally overvalued. In present scenario the stock shall trade below $220. In case if the company does not pays dividends according to the expectations of shareholders, the stock may see a fall in its market value. Week 5 Discussion Part I Hedging is a tool that is used by the investors to lower their risk that they may sustain due to fluctuation in the price of commodity, exchange rates or the interest rates (Brigham, E. F., & Ehrhardt, M. C. 2014). It is a method of minimizing or transferring risk. It is used as a strategy to protect oneself from the prevailing uncertainties. A risk-free portfolio of stock and options can be created using hedging. The two methods of hedging are discussed below: Call Option Method Under this method a risk-free hedge portfolio is created through call options. Call option is an arrangement in which the investor gets a right for buying stock or bond at a definite price and also within a definite time. In case if the price of the call increased the profit is booked by the investor. It gives an opportunity to the investor to leverage their money for higher return on investment. Put Option Method Under this method a risk-free hedge portfolio is created by using put options. It is an option contract that gives the right to the investor for selling stock or bond at a definite price and also within a definite time. Call option provides risk-free hedging for buying the stocks or bonds whereas put option provides for selling the stock or bonds. In case of decline in the price of the security the profit is booked by the investor by purchasing the security. It provides an opportunity to investors to speculate an investment they do not own or to hedge an investment they own. Part II Following hypothetical figures have been assumed for the purpose of calculating WACC. E = Company' Equity = $1,200,000 D = Company's Debts = $800,000 V = Total Equity and Debts = $2,000,000 Re = Cost of Equity = 0.06 Rd = Cost of Debt = 0.05 T = Tax Rate = 35% The Formula for Weighted Average Cost of Capital is: WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)] Substituting values in formula we get: WACC = ((1200000/2000000)*0.06)+(((800000/2000000)*0.05)*(1-0.35)) = 0.049 or 49% The weighted average cost of capital (WACC) of the company is 4.9%. It means that for each dollar of the funds that the company raises from its investors, the company must pay $0.05 in return. The remaining 0.95 can be used by the company for its business or for purchasing assets. The WACC of the company is low so it is suggested that the company should expand it. References Brigham, E. F., & Ehrhardt, M. C. (2014). Financial management (14th ed.). Mason, OH: SouthWestern Cengage Learning