1. What should be your reasonable required rate of return to use in order to value stock and why?
(The question asked what percentage you should expect as your required rate of return or as your expected return on investing in a stock. You could answer it in percentage term and explain your reasons those justify the percentage. Your answer didn’t need to be exact with my answer to get points. Your reasoning and your explanation of your logic were what I looked for as I had told you on the instruction of the assignment to clearly explain your logic.)
Answer: The reasonable required rate of return should include a rate of inflation, an equity risk premium, and is adjusted for stock price volatility. (The answer is not limited to the above since it’s subjective.) An investor would require at least a rate of return equal to an inflation rate to order to maintain value of money. However, a higher return than the inflation rate should be expected for someone who decides to invest in stock. Since stock is more volatile than bond or even corporate bond, stock investment should yield or require return higher than that of bond investment. Therefore, the investors should be compensated for taking equity risk (buying and holding on to stock). This part can be estimated by calculating the equity risk premium which refers to stock market return over inflation rate. Or, the investors can use a historical average stock market return as a rule of thumb required rate of return. Lastly, if the price of the stock that the investor plans to invest is more volatile than an average stock’s volatility, the investor may want to adjust his/her required rate of return according to the volatility of the particular stock.
2. How will you value a company’s stock of a listed company that its board intends to pay no dividend and net incomes, if any, will be given away to charity?
(The question asked how to value a company that pays no dividend and intends not to pay out any incomes neither.)
Answer: Since the company doesn’t pay out dividend, we couldn’t value the stock based on dividend as our cash flow. However, it doesn’t mean the company has no value. For example, we could buy the company and become an owner or a major shareholder. Then, we could change the dividend policy or use the company’s income as we see fit. Therefore, we could value the company as a whole using company’s earnings as cash flow. Or we can use company’s operating cash flow or free cash flow to come up with the valuation. On another school of thought, we could compare earnings or other financial numbers to those of companies with similar business structure. For example, if the company in question has earnings of X and another company (say company “A”) with similar business structure has earnings of 2X. Then we can estimate a ballpark figure of value of the company in question as half of the value of company A. The ballpark figure can also be adjusted further by debt level or future outlook for example.
How will you value gold (gold bullion) which do not yield cash flow or dividend?
(The question asked how to value gold.)
Answer: Well, some might say to look at gold supply and demand to get some price indications just like when we value other commodities. However, gold is the only commodity where the amount of supply is
literally about 100 times as much as the amount physically used in any year. That is not true of any other commodities, such as wheat or copper, where total supply and annual consumption are much closer in balance, and true shortages can develop. There is never any shortage of gold. So gold’s value is entirely dependent on psychology or those fundamentals that drive psychology. Hence, gold production and consumption figures (supply & demand) could be ignore in their entireties in analyzing gold valuation as annual production and consumption of gold are tiny fraction of supply. Regardless of how much they change, there’s nothing to do with the price of gold. So Price expectation is therefore based wholly on such factors as inflation and the value of the dollar because those are the factors that drive psychology. (I did give point to those who answer supply and demand as way to evaluate gold’s value. Answers to these questions are subjective. You just need to defend your answer in a logical manner to get point.)
1. What should be your reasonable required rate of return to use in order to value stock and why?(The question asked what percentage you should expect as your required rate of return or as your expected return on investing in a stock. You could answer it in percentage term and explain your reasons those justify the percentage. Your answer didn’t need to be exact with my answer to get points. Your reasoning and your explanation of your logic were what I looked for as I had told you on the instruction of the assignment to clearly explain your logic.)Answer: The reasonable required rate of return should include a rate of inflation, an equity risk premium, and is adjusted for stock price volatility. (The answer is not limited to the above since it’s subjective.) An investor would require at least a rate of return equal to an inflation rate to order to maintain value of money. However, a higher return than the inflation rate should be expected for someone who decides to invest in stock. Since stock is more volatile than bond or even corporate bond, stock investment should yield or require return higher than that of bond investment. Therefore, the investors should be compensated for taking equity risk (buying and holding on to stock). This part can be estimated by calculating the equity risk premium which refers to stock market return over inflation rate. Or, the investors can use a historical average stock market return as a rule of thumb required rate of return. Lastly, if the price of the stock that the investor plans to invest is more volatile than an average stock’s volatility, the investor may want to adjust his/her required rate of return according to the volatility of the particular stock.2. How will you value a company’s stock of a listed company that its board intends to pay no dividend and net incomes, if any, will be given away to charity?(The question asked how to value a company that pays no dividend and intends not to pay out any incomes neither.)
Answer: Since the company doesn’t pay out dividend, we couldn’t value the stock based on dividend as our cash flow. However, it doesn’t mean the company has no value. For example, we could buy the company and become an owner or a major shareholder. Then, we could change the dividend policy or use the company’s income as we see fit. Therefore, we could value the company as a whole using company’s earnings as cash flow. Or we can use company’s operating cash flow or free cash flow to come up with the valuation. On another school of thought, we could compare earnings or other financial numbers to those of companies with similar business structure. For example, if the company in question has earnings of X and another company (say company “A”) with similar business structure has earnings of 2X. Then we can estimate a ballpark figure of value of the company in question as half of the value of company A. The ballpark figure can also be adjusted further by debt level or future outlook for example.
How will you value gold (gold bullion) which do not yield cash flow or dividend?
(The question asked how to value gold.)
Answer: Well, some might say to look at gold supply and demand to get some price indications just like when we value other commodities. However, gold is the only commodity where the amount of supply is
literally about 100 times as much as the amount physically used in any year. That is not true of any other commodities, such as wheat or copper, where total supply and annual consumption are much closer in balance, and true shortages can develop. There is never any shortage of gold. So gold’s value is entirely dependent on psychology or those fundamentals that drive psychology. Hence, gold production and consumption figures (supply & demand) could be ignore in their entireties in analyzing gold valuation as annual production and consumption of gold are tiny fraction of supply. Regardless of how much they change, there’s nothing to do with the price of gold. So Price expectation is therefore based wholly on such factors as inflation and the value of the dollar because those are the factors that drive psychology. (I did give point to those who answer supply and demand as way to evaluate gold’s value. Answers to these questions are subjective. You just need to defend your answer in a logical manner to get point.)
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