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5.3 Discussion: Cash Flows and Stock Valuation

1. Respond to two of your classmates’ postings, writing as if you were reviewing their postings in an academic journal.  Your discussion responses should therefore answer the following questions as applicable:

a. Are your classmates’ arguments articulate and logical?  Are their facts correct?

b. Are your classmates’ interpretations reasonable and consistent with experts in the field?  Are your classmates consistent with both the substance and intent of their references?

2. Your discussion responses should not focus on whether or not you agree with your classmates, but how well they present their positions.  Each response should be at least 150 words in length and cite at least one academic source. Please strive to make your discussion responses either extend the scholarly discussion in a productive direction, or offer thoughtful analysis that helps your classmates deepen their own understanding.

Peer Review 1: (Sailika)

It is true that the value of a share of stock depends a lot on dividends. Companies pay dividends to share their profit with shareholders. It creates a good bond with investors. The share price also represents future cash flows too.  

The value of a share of stock is equal to the present value of future dividend earnings. If D1 is next year's dividend(year 1), D2 of the dividend of year2……etc till infinity.

The current value of the share=P0=D1/(1+R)+D2/((1+R ^2)+ D3/((1+R)^3)+…….to infinity If the dividend amount is =D, constant every year in perpetuity and required rate of return is R;

The present value of constant dividend of D in perpetuity =D/R

Hence current price=D/R

If there is growth in dividend with growth rate =g

Present value of constant growth dividend to perpetuity=P0=D1/(R-g)

Hence, we can say that the higher the dividend expectation, the higher will be the present value of dividend earnings and the higher will be the value of a share of stock. Also, it can be seen that companies having a high growth rate will have high prices compared to other companies with the same current dividend but no growth in the dividend.

Dividend policy: We know that the growth of a company depends on its retained earnings. A company can use its income either by paying dividends or by retaining the earnings for the betterment of the company. In this way, a company can increase its growth and expansion. But in both ways, these earnings are part of shareholders' profit and their income or wealth. Companies that are in sunrise possess high growth potential because these have high growth rates & also promise for a rapid boom. Such companies focus on their expansion instead of dividend payout. Shareholders of such companies may be willing for dividends payout so that there will be profit to shareholders by increment in their wealth. In such cases, there will be a capital gain for shareholders but as an appreciation of share price but there may not be a dividend yield. So in these cases, the investors buy these shares in expectation of high capital gain.

Reference:

Ross, S. A., Westerfield, R., & Jordan, B. D. (2019). Fundamentals of corporate finance. Tata McGraw-Hill Education.

Peer Review 2: (Sai Chaitanya)

1. The stock market is synonym to constant change. The value of stocks rise and fall time to time depending on various aspects related to the corporations, economy or international affairs. Investors who have been in the market from a long time know how it works but for the new investors without proper knowledge or guidance it is tough to analyze trading decisions. There are many models of valuation of stocks one of which is Dividend discount model also known as DDM which states that the present value of a stock is calculated as a sum of all future payments that have been discounted to net present value. In simple terms, it means that the value of stock is calculated on the dividends which are paid on those stocks because the investors focus on the returns they get on their investments hence the value of a stock depends on the dividends.

Huge corporations like Google do not pay their stockholders dividends because they reinvest the amount of those dividends which are to be paid into the corporation with the aim to utilize the money in the growth and expansion of their business. A few investors who focus on the long term gains invest in such stocks as the company’s growth results in an increased stock value which when sold would yield them profits. Thus, such investors prefer these non dividend paying stocks. (Stocks That Do Not Pay Dividends Have Portfolio Value Too, 2020) 

Reference: 

Stocks That Do Not Pay Dividends Have Portfolio Value Too. (2020, May 6). The Balance. https://www.thebalance.com/value-of-stocks-without-dividends-357450

 6.3 Discussion: Capital Budgeting

1. Respond to two of your classmates’ postings, writing as if you were reviewing their postings in an academic journal.  Your discussion responses should therefore answer the following questions as applicable:

a. Are your classmates’ arguments articulate and logical?  Are their facts correct?

b. Are your classmates’ interpretations reasonable and consistent with experts in the field?  Are your classmates consistent with both the substance and intent of their references?

2. Your discussion responses should not focus on whether or not you agree with your classmates, but how well they present their positions.  Each response should be at least 150 words in length and cite at least one academic source. Please strive to make your discussion responses either extend the scholarly discussion in a productive direction, or offer thoughtful analysis that helps your classmates deepen their own understanding.

Peer Review 1: (Sowmya Gungur)

Capital Budgeting is a tool used in the investment assessment procedure. Capital budgeting is adopted by various organizations when they need to evaluate an investment option. It allows organization to make decisions about investment and opt the best option available that will help them increase the value of the company in the long run. This process of evaluation is very important because the organization is investing their capital in the investment therefore it is important that the organization selects such investment that it helps increase the value of the capital invested. This helps them be prepared for the future years to come and make them financially secure. Capital budgeting is applicable to any type of organization as investment decisions are taken by all types of organizations and this process helps them evaluate the risk involved and the returns they will receive on the said investment. The chapter specifies that non-profit organizations budget must be accompanied by strategy that has capital campaigns and various other financial techniques. (Ross, Westerfield, & Jordan, 2016)

Reference: Ross, S. A., Westerfield, R., & Jordan, B. D. (2019). Fundamentals of corporate finance. Tata McGraw-Hill Education.

Peer Review 2: (Anjana Reddy)

Capital budgeting is a tool used by managers to make efficient financial choices when it comes to investing the capital of the company in such way it creates more value for the firm. This process of capital budgeting helps company to take decisions related to investments to be made in a new project, to buy a capital asset, acquisition of a company, etc. It helps the company to compare the cost of investment with the future cash flow to be generated from the investment. If the future cash flow is more than the investment it is preferred as it is adding value to the company. Capital budgeting roots from the time value of money and use PV or discounted cash flow to assess investments. Any organization who is about to make a huge investment decision that will have an impact on the capital and value of the company can incorporate the process of capital budgeting to analyze the investment choices and make efficient decisions. (Bradshaw, 2018)

2. Yes, Capital budgeting is also applicable to Non-profit making organizations as they make investment decisions too hence the same rules and standards apply for them like the other profit making organizations but only differences lie when it comes to the revenue of such non-profit organizations which is different compared to others.

Reference: Bradshaw, D. (2018, August 28). Justifying Investments with the Capital Budgeting Process. Toptal Finance Blog. https://www.toptal.com/finance/budgeting/capital-budgeting-process