Week 4 Discussion: Interest Rate, Stock Valuation, Risk and Returns
Part 1: Interest Rates
Many managers do not understand the various ways that interest rates can affect business decisions. For example, if your company decided to build a plant with a 30-year life and short-term debt financing (renewed annually), the cost of the plant could skyrocket if interest rates were to return to their previous highs of 12% to 14%. On the other hand, locking into high, long-term rates could be very costly also with a long period when low short-term interest rates were to be available. As you can see, the ability to know your economic environment and its impact on projected interest rates can be crucial to making good financing decisions.
Describe two to three macroeconomic factors that influence interest rates in general. Explain the effects of each factor on interest rates.
Now think about the industry in which you are employed or one in which you have past experience. To what macroeconomic factors is your industry most sensitive?
Describe two contemporary factors that seem to be impacting your industry today, and identify their impacts on the interest rates experienced within your chosen industry.
Support your comments with your own experiences, the weekly resources, and/or additional research. Use APA throughout and provide appropriate in-text citations and references.
Part 2: Stock Valuation, Risk and Returns
Dividend Discount Model Stock Valuation
How to value a company using discounted cash flow (DCF)
Stock Valuation and Investment Decisions
The links above contain information on stock valuation, risk, and returns. Please review each one of them. Based on the knowledge gained from the materials presented in the links above, complete the following activities:
Present a detailed discussion of what you learned about stock valuation. Provide examples of how your company has used the concepts. Do you believe financing a company’s operation using stock is better than financing with bonds? Why or why not? Support your discussion with a numerical example.
Based on the materials presented in the “Risk and Return” video, present a discussion on why the materials are important in financial decision making. How would you incorporate risk and return in your financing decisions?
1. Post your initial response to later than Saturday .
2. Read and respond to your classmates. Respond to at least 3 of your classmates’ posts. Below are additional suggestions on how to respond to your classmates’ discussions
1st student response (Srujan Gandla) :
Part 1: Interest rates
As we know the term interest rate is defined as the amount received which is in relation to the amount we loaned. I think there is the number of forces which is taken into consideration especially evaluating the current and future interest rates (Nick, 2018). Main prime factors are
1) U.S economy Condition: if the U.S economy is growing, there are more jobs for consumers which help lending through banks for buying car, home etc and leads to increase interest rate based on demand.
2) Inflationary pressures: it will affect interest rates, as most of the loan is based on fixed rates, so the lender may show reluctant for any period of time if the repaid value is less than Purchasing value.
3) International forces: it depends on if the foreign investors are ready to lend any money to the U.S
4) Federal government: any actions or decisions by government impact the interest rates because it being the largest borrower.
5) Dollar fluctuation: the dollar being the main currency in global trade, may lead to instability in international and domestic interest rates (Nick, 2018).
The most common macroeconomics factors which impact my industry (pharmaceutical)is the U.S economy condition and dollar fluctuations based on share value. The interest rates may rise because of more demand among our sector by the economic condition of the country. Fluctuations of a dollar in the share market may reduce investors and increase interest rates. Some of the other monetary factors are political executions, competitors products share value, income level, overall GDP and natural calamities. The main components which show an impact on the industry are 1) social factors 2) demographic conditions 3) environmental 4) technological issues 5) economy situation (Nick, 2018).
Finally, interest rates depend on several macroeconomics factors and effect any type of industry.
Part 2: stock valuation, risk, and return
From the videos, it clearly showed how stock valuations are calculated and how the company expects the investment returns for their future investments. The main criteria like the loan cost impacts and credit status which makes the investors believe and expect their future investments. For me the stocks are the good option than bonds, a good example of my own company if we offer machines for $10 per year, so what amount we will end up paying off this machine and say it zero maintenance cost.
So here $10 is owners profit, which is free and clear
But for next year the value will not be $10, which is now and invest you get $10.5 or $11 by the next year. If you see risk or return, if you wish to get 10% rate of return, we should use the discount rate of 10% and you except the rate of return is $9.09 which is worth today(DPV=FV/1+R). The stock valuation is not very easy in practice as it allows to estimate free cash flow that to future only. But the bonds are safer in terms of initial investment and it will back anytime. But stocks will deliver high returns with having greater risk. (if the organizations fall, all the stockholders lose their investment). Another step in risk or return for any making any financial decision is simple which is greater the risk greater the return as explained in above example and it varies from one financial manager to another financial manager to trade off risk- return (Bodie, et al:1980).
Bodie, Z., & Victor I. Rosansky. (1980). Risk and Return in Commodity Futures. Financial Analysts Journal, 36(3), 27-39. Retrieved from http://www.jstor.org/stable/4478342
Retrieved from Nick timiraos, 2018
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2nd Student Response (Hyndavi Mandava) :
In society, the term interest rates have been creating its own integrity by providing and offering based on human behaviors. In the organizations, most managers should have effective knowledge to understand the ways of interest rates. So in many cases, they are taking wrong decisions it should lead to getting lost in the business. When we start the business, first of all, we should have the basic plan can have to decide to build a plant with a 30-year life. Based on the financing it has been renewed annually we have to return the amount by adding the interest. On the other hand, most of the people are preferred to take the amount for a long period of time by asking them to low-interest rates (Cheung, 2019).
Based on the requirement of the client they should move with either for short time return process or long term return process. As per the economic growth, we have to know that to keep a better environment and it has been projected its impact on the interest rates. The manager should have to take care of the company’s financial assets by providing better decisions to occupy positions (Hassan, 2019).
Stock Valuation, Risk and Returns
Stock valuation: Within the company in order to the process of calculating overall values and their stocks is the way it is known as stock valuation. Based on the decision of investors it has been predicting future market prices helps to find out which stocks are undervalued. For the process of investment, it was useful to remember that an NPV of zero does not make any money. It means we will make neither more nor less than the rate of return on our investment that is implied by our discount rate. By various internal and external factors, the capital structure decision has been considered for the firm is affected. Based on the potential differences and trade-off existed in the business organization the risk and return have been depending (Liu, 2019).
Cheung, E. C., Ng, M. C., & Ma, Y. C. (2019). The Multi-Faceted Effects of Partial Interest Rate Liberalization in China. Chinese Economy, 52(2), 171–191. https://doi.org/10.1080/10971475.2018.1545359
Hassan, K., Hoque, A., & Osman, M. (2019). Is Long Rate Decoupling from Short Rate? Revisiting Expectation Hypothesis of Australian Term Structure of Interest Rate. Journal of Developing Areas, 53(3), 77–91. https://doi.org/10.1353/jda.2019.0039
Liu, K. (2019). China’s Interest Rate Pass-Through to Government Bonds and Monetary Independence. Journal of Developing Areas, 53(2), 169–177. https://doi.org/10.1353/jda.2019.0028