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Investment Valuations - Coggle Diagram
Investment Valuations
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Valuation using CAPM
CAPM pricing is widely used for the pricing of risky securities, generating expected returns for assets given the risk of those assets and calculating the cost of equty
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The market rate of return is the overall rate of return on the market, the return on some relevant benchmark index such as S&PO500 is a good estimate for market rate of return
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Measuring value creation
Total shareholder return
Total shareholder return is the total amount returned to an investor equal to the capital gain or loss on a share plus all dividends
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Despite the ease of calculation this method is subject to limitations as it uses market prices as the base. These are subject to market volatility, therefore it would only be meaningful if the performance is compared between companies in the same sector with same level of risk
Market value added
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Market value represents the current value of the company whereas capital represents the funds invested by the shareholders and long term debt holders
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Stock market influences
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For any public issue or right issue to be successful it is essential that the shareholders are kept informed about how funds are used and the positive NPV of any new projects
The amount of value increase is not essential but shareholders should be kept informed about the success of the project
Communications to shareholders and the stock exchange are an important part of the process of maintaining confidence in a c omapny and access to capital funds at fair prices
Market efficiency is measure by how quickly the markets respond to the news or information that is reflected by an increase or decease in the share price
Competitive advantage is attained by the value created as a result of undertaking the new project or venture
Economic value added
A measure of profitability and wealth created for shareholders over and above the cost of invested capital
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The rationale behind multiplying the capital invested by WACC is to assess the cost of using the capital invested by shareholders
It determines whether the company is adding more wealth to a shareholder value by earning a higher rate of return on the funds invested than the cost of the funds
A positive EVA indicates that a project has recouped its cost of capital while a negative EVA indicates that the company has not made sufficient profits to recover its cost of running the company
Strengths
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It looks at economic value and presents a better picture of the company based on the idea that a company must cover both the operating costs as well as the capital costs
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Weaknesses
EVA is restricted to specific or short term projects as it does not take into account the present value of future cash flows
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Assets such as brand and reputation which enhance the value of the company but are not recorded in SOFP are not considered, this limits its scope for companies with intangible assets such as technology companies