<Recall that I had said earlier in the thread that the intrinsic value is typically calculated using the long bond yield, but that the value to an investor must be calculated using that individual's return requirement as the discount rate.>
I think the 20 year bond yield is more appropriate, due the fact that it more closely mirrors a typical long term equity investment horizon.
<, but that the value to an investor must be calculated using that individual's return requirement as the discount rate.>
"that individual's return requirement" should reflect the oppurtunity cost of investing in that particular vehicle in lieu of investing in the risk free instrument. This is derived via a mathematical equation that calculates the oppurtunity cost of capital or the weighted average cost of capital. This ends up being the weighted adjusted risk of the primary funding sources - equity, debt, capitalized leases, synthetic instruments, etc. - plus the risk free rate, which I referred to earlier as the 20 yr treasury rate.
For Intel's FY 96 that rate truned out ot be just over 13%. For MSFT's FY 96, it was 11.1%. INTC's equity is more volatile than MSFT's, therefore its cost of equity capital (due to its business risk) was greater. These are the barriers the companies must overcome to create value, and these are the numbers that should be used as a discounting rate. Never, should an investor use one pat rate, for each company has a a different situation. Very few, if any, growth companies have an equity cost of capital at or under 9%.
As usual, for more info see rcmfinancial.com unser the papers link in the top menu. (best viewed with IE). |
