Finance Assessing a Potential Investment in Facebook

Finance

Assessing a Potential Investment in Facebook

Under the concept of time value, money today is worth more than the same amount in the future (Nellis and Parker, 2006). This is over time, inflation will erode the value of money and in a years time $100 will buy less than it will buy today. If Facebook is offering a $100,000 bond, for one year, the investor, wanting to make a profit and account for the money that could be made elsewhere, will offer less that the face value.

Using the CAPM, shown in question 2, to allow for the time value of money, the interest rates I may get elsewhere and the risk associated with Facebook investments, the price I would pay is $86,333. However, if I were risk adverse I may want to discount this even further to a gain a higher risk premium, as there are other indicators of risk, such as a low profit margin and return on assets and equity, however the cash flow appears good in the current and quick ratios (see table 2).

Question 2

To assess how much one may pay for a bond it is necessary to look at the rates that may be obtained elsewhere and account for the risk that is involved. A good tool to assess the required rate of return is the capital asset pricing model. This is a simple formula, where the expected rate of return is calculated by taking the current risk free rate (usually the 10-year government bonds) and then adding to that the equality risk premium multiple by the beta. The equality risk premium is the additional amount that the stock market averages, and the beta is a measure of the share price volatility, usually interpreted as indicating risk, the equation is written like this E (R) = r + (ERP x b).

The current risk free rate is 2.88% (Bloomberg, 2013) and we will assume that the current equity risk premium is 7%. The beta for Facebook is 1.85 (Yahoo Finance, 2013). This gives us the following equation 2.88(7 x 1.85) = 15.83. This is the expected rate of return. This can now be used to discount the bond.

The equation to discount the future value is PV = FV / (1+r) n where PV is the present value, FV is the future value ($100,000 in this case), r is the discount rate (15.83% in this case) and n is the number f years (1 in this case). This gives 100,000/(1+15.83)1 = 86,333

Question 3

The price an investor is willing to pay will vary by company, and reflect the firms' performance as well as the investor beliefs. Looking at other firms in the same industry, I would pay more for a Google bond; the firm is more established and is less risky. This is reflected in the wider are of operations and income generation as well as the beta which is only 1.09, the firm also has better profit margins and a higher level or return on assets and equity (see table 2). Google appears to present a greater level of stability.

By comparison, I may pay less for a SINA Corp bond, this company has a higher beta, and appears to present a high level of risk, with the current losses made in terms of the profits and the return, however the firm appears to have liquidity as seen with the current and the quick ratio (as seen in table 2). The risk may also be seen as increased as this is a firm based in Shanghai. The potential payment calculation is shown below in table 1.

Figure 1; Potential bond payments for Google and SINA Corp

Risk free rate

ERP

Beta

R (R)

Bond payment

Google

2.88

7

1.09

10.51

90,489

SINA

2.88

7

2.07

17.37

85,200

By looking at all three firms it is possible to see how and why we may perceive Google as less risk and SINA as more risk. The performance and assessment ratios are shown below in table 3.

Figure 2; Ratios for the three firms