Term Paper: Finance Such as Present Value and Capital

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¶ … finance such as present value and capital asset pricing model to name a couple. This paper will explore three business models in order to better understand present value and discount rates. This paper will look at the security of equity future and more specifically Wal-Mart's performance. This paper will also examine the relationship between CAPM vs. APT and discuss the method used when determining a rate of return and capital budgeting purposes.

You inherit an oil well. This oil well is believed to have three years worth of oil left before it dries up. Here is how much income this oil well is projected to bring you each year for the next three years: Year 1: $160,000; Year 2: $210,000; Year 3: $320,000. Compute the present value of this stream of income for a discount rate of 5%, 12%, and 17%. First of all, it is understood the equation for computing present is as follows:

PV = CF r) t CF equals the amount expected to be made. "R" is the discount rate.

Year One:

Discount Rate of 5%: PV = $160,000 or 160,000 = $152,380.95

Discount Rate of 12%: PV = $160,000 or 160,000 = $142,857.14

Discount Rate of 17%: PV = $160,000 or 60,000 = $136,752.13

Year Two:

Discount Rate of 5%: PV = $210,000 = $190,476.19

Discount Rate of 12%: PV = $210,000 = $167,416.71

Discount Rate of 17%: PV = $210,000 = $153,407.85

Year Three:

Discount Rate of 5%: PV = $320,000 = $276,428.03

Discount Rate of 12%: PV = $320,000 = $227,769.68

Discount Rate of 17%: PV = $320,000 = $199,798.58

Part 2: Three Sample Business Plans

There are Missing Materials for this section. Unable to complete without Business Plans)

Module 2: Session Long Project

One type of security is called an equity future. This is a contract guaranteeing your shares of a company to be delivered to you not today, but sometime in the future. What you would pay for such a contract? It depends on what price you expect the shares to be at in the future, and how volatile the stock is at the time of purchase or in other words what discount rate you should value this future payment of stocks). By looking at Yahoo Finance.com and at the five-year chart for Johnson and Johnson, the reference company I chose, one can learn a lot about the company.

In comparison with Johnson and Johnson, what would you pay for 100 shares of Wal-Mart to be delivered to you in one year? Is it like comparing apples to orange or do the two companies have more in common than thought?

Johnson and Johnson is a diverse corporation specializing in the production of pharmaceuticals and first aid care products.. One can take a look at the stock price to see any trends or changes during the last five years. Below, from Yahoo Finance is Johnson and Johnson's latest stock chart.

From this chart, one can see how Johnson and Johnson's stock has progressed over the year from about $50 to $63.58 on Thursday. This means the company's stock not only reflects the company's growth and sales but also has shown improvement over time. Because the stock has grown in price, many may hesitate to buy if one is looking for a deal. As a result, financial analysts on Yahoo Finance rate the stock at 2.3 on a scale of 1 to 5 (1 being a strong buy and 5 being a strong sell). Right now the stock would be considered a seller's market. Still the price could continue in its upward trend making it more desirable to buyers. Overall, drug company stock is usually a safe investment.

Walmart is a retail giant. Wal-Mart's five-year chart is slightly different from Johnson and Johnson's. Their stock price starts out a lot higher and falls in the beginning of the chart and then gains momentum to gain ground. Still the stock manages to remain in the high fifty-dollar range and steady for the last year. These radical changes in stock suggest it has adjusted with the times and the economy. The stock may have continued to climb but not soar due to various issues within the company like employee relations and union problems out west. Analysts at Yahoo Finance give a recommendation of 2.2 on a scale of 1 to 5 (1 being a strong buy and 5 being a strong sell). Right now the stock would be considered a seller's market. Still the price could continue in its upward trend making it more desirable to buyers.

Overall, both stocks are considered volatile because of these middle ground ratings. This means the stock is unstable in the mind of the analyst because the stock could go either way in the future. This makes deciding to purchase, as am equity future difficult because no one can predict how the market will change over the next year. People can make educated guesses especially with respect to Wal-Mart that consumer spending and confidence is on the rise more than in recent years but still there are a lot of other factors to consider like rising energy costs and the war in Iraq. All of these things help determine if the consumer will spend money.

So should the consumer purchase a hundred shares of Wal-Mart stock to be delivered a year from now? Judging from the five-year chart and the fact the stock closed at $52.32 one year ago and it is currently trading at $52.97; it is safe to say despite analyst opinion, Wal-mart is a safe buy because if anything not much will change. However, if one is looking for a moneymaker, this is not the stock to expect much future returns. Still analysts are anticipating the stock will reach $63.85 in one year but this is only a guess. If one is a risk taker and willing to ride it out, then this is a stock to consider.

Module 3, Part 1: CAPM VS. APT

The Capital Asset Pricing Model or CAPM is not the only asset-pricing model around. One of the competing approaches asset pricing is called the Arbitrage Pricing Theory or APT, which was developed to address some of the criticisms of the CAPM. Do you think APT or the CAPM is the best approach for a financial professional to use?

There seems to be two schools of though on the validity of CAPM and APT. There are people who use CAPM as a method to analyze risk and others who believe APT is a better approach because it builds upon the CAPM theory. This is a positive when understanding risk because APT does not leave room for mistakes. For financial professionals it is of utmost importance to assess risk as accurately as possible in order to sell a stock idea to a client. Clients are more than often risk adverse and do not want to take a loss with the money invested. In this respect most clients enjoy a conservative approach, which means the less risk involved the better. Because APT builds upon CAPM and takes the theory to a new level, it requires further analysis to prove the point. Still first in order to understand APT, one must first have a grasp of CAPM works.

First of all, CAPM is not at versatile as APT. CAPM can only work to assess risk in the long run scenario. Where does this leave the short run for an investor who only wants a six-month period? Still CAPM "states that the return on a stock depends on whether the stock's price follows prices in the market as a whole" (Anonymous, p. 1). The more a stock follows the market, the greater the return. CAPM divides risk into two categories, systematic and unsystematic. CAPM also assumes the investor does not have inside knowledge and that the Beta is known. This is the only way an expected return can be determined with CAPM. Mark McCracken defines Beta as "equals 1.0000. 1 exactly. Each company also has a beta. A company's beta is that company's risk compared to the risk of the overall market. If the company has a beta of 3.0, then it is said to be 3 times more risky than the overall market" (par. 1). The amount of risk and the type of risk can be determined by diversification. Systematic risk, which is market risk or undiversafiable risk, is the portion of an asset's risk that cannot be eliminated via diversification. The systematic risk indicates how including a particular asset in a diversified portfolio will contribute to the riskiness of the portfolio. Unsystematic risk, which is firm-specific or diversifiable risk, is the portion of an asset's total risk that can be eliminated by including the security as part of a diversifiable portfolio (Mathis, CAPM, par. 1). So obviously there are some stocks that will not be included in a diverse portfolio because of its defined risk under this theory. CAPM digs deeper to assess… [END OF PREVIEW]

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