This paper is about the time value of money. It asks to price out some bonds, and then discusses the financial variable that reflect the risk, and therefore the discount rate, of the different securities. After calculating a number of different financial ratios, the discount rates are re – visited for these companies.
¶ … Value of Money
My SLP company is Wal-Mart. For me I would pay less than $100,000 for this bond, because I know that the $100,000 face value of the bond is not going to have the same purchasing power in a year as it does today. The value of the bond will therefore be less than $100,000, based on the prevailing interest rate. Wal-Mart is a company with a high amount of cash flow that is quite reliable. Thus it is not expected that Wal-Mart would pay much in the way of interest, maybe 2% per year. This implies the value of the bond would be around $98,000.
The discount rate for this bond, based on a $98,000 price, would be 2.04%, as calculated by ($100,000 -- 98,000) / 98000. This reflects the return that the bond offers to the investor.
Target is a company in the same industry as Wal-Mart. I would pay less for a Target bond. Target is a stable enough company, but it does not have the same level of stability and diversification as Wal-Mart does. Therefore I would demand a risk premium for a Target bond, and that risk premium is going to mean that I will pay less for that bond, and therefore earn a bigger return, than I would for Wal-Mart. I would pay $97,000 for a Target bond, which gives a return of (100,000 -- 97,000) / 97,000 = 3.09%.
When one considers the things you want in a company when evaluating debt, you want to see stable cash flows, a lack of long-term debt and a healthy liquidity position. Wal-Mart is an excellent company in this regard, so there are not too many competitors of Wal-Mart that are actually more attractive. One that does have greater appeal is Amazon. While Wal-Mart is one of the largest online retailers, Amazon dominates this space. It has billions in cash, and its revenues are increasing significantly every year -- a 27% improvement last year. Thus I would pay more for an Amazon bond as I feel that company is even more reliable than Wal-Mart, because it is the number one in the industry and growing at such a large rate that other companies cannot even compete any more. I would pay $99,000 for an Amazon bond, which gives me a return of 1.01% for the year, not much more than what you would get on a Treasury bond.
Part II.
The debt to equity ratio for Wal-Mart is 1.66, as calculated by $126,762 / $76,343.
The debt to equity ratio for Target is $31,605 / $16,558 = 1.908
The debt to equity ratio for Amazon is $24,363 / $8,192 = 2.97
The financial figures for these three companies are as follows:
Wal-Mart
Target
Amazon
Profit Margin
3.61
3.27
0.19
ROA
8.62
5.03
0.48
ROE
24.09
14.84
1.59
Beta
0.41
0.78
0.52
Current ratio
0.83
0.9
1.07
Quick ratio
0.21
0.05
0.67
The betas are a measure of risk with a beta of 1.0 being average market risk. This illustrates that all three of these companies have low risk. I was right about Amazon being a relatively low risk firm, even though its other financial characteristics are not particularly impressive. It barely has a profit margin, even less than that of Wal-Mart, though it does have a better current and quick ratio. This is in part because it carries less inventory than those other two. Almost all of the current assets at Target are in inventory, which is a bit risky.
I would probably adjust my on prices a bit based on this. I think the discount rate should be lowest for Wal-Mart and highest for Target, but Amazon should be in between the two. Perhaps then Wal-Mart's bond should be priced at $99,000, and then Amazon's at $98,000 and the price of Target's bond can remain the same at $97,000.
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