You have earned the price
of admission. Now that you have an understanding of
the time value of money, the risk/return relationship,
and basic accounting notions, we are ready to value
investments in a business. Sometimes the return from
these investments is fixed (as with bonds) and sometimes
variable (as with stock).
No matter the type of investment you are examining,
the value depends on the same fundamental question:
How much would an investor be willing to pay for the
assets' income-producing potential? Given that the question
is always the same, you would think that the method
for calculating the value would be the same -- and,
for the most part, it is!
This chapter begins with a review of the basic DCF
method, and its importance in investment valuation.
Next, we examine some characteristics debt investments,
particularly bonds,
that provide
the most straightforward valuation of any type of investment.
Then we turn our attention to the equity investments
in a company--the glamorous world of stocks. Finally,
we look at the valuation of options
- a
bet placed on another security, typically common stock.
Looking ahead. This chapter is a precursor to chapter
5, in which we consider valuation of an entire business,
rather than discrete investment interests. We will also
look at how the DCF model is related to the three principal
business valuation methods: asset, income/investment
and market/comparables.
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Chapter 3 - Accounting Basics
