Introduction
Companies are in the business of making profits. As such it is important that the companies understand their investments and their resources. There are various tools and methods used in evaluating investment viabilities. They include Stock Valuation, Total Returns, CAPM, WACC and Flotation Costs.
Stock Valuation
Stock valuation enables companies to evaluate the value of the securities they purchase. There are various methods of stock evaluation but the fundamental objective is to find out the intrinsic value of an investment. In this case, the stock in question had to be analyzed in terms of how much the capital gains are, as well as the dividend yield (Ross et al., 2016). The percentage of total return is a percentage of the value of the initial amount invested in the stock. It advises investors on whether the stocks are worth buying or holding.
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Total Return
Total Return represents the actual value of the rate of return of any investment or a portfolio of investments. It is simply the value that an investor derives from investing in a security for a specific duration of time. It includes dividends, capital gains, interest and distributions (Ross et al., 2016). While the total return represents the growth of an investment, it is important that investors look at the big picture and not just the metrics. Investors and companies use total return to determine and manage their expectations.
CAPM
The Capital Asset Pricing Model (CAPM) is a tool that evaluates the relationship between expected returns and the associated risk (Ross et al., 2016). CAPM is an important tool in determining the viability of risky investments. CAPM recognizes that investors expect returns that compensate for the time value of money, the risks involved, and of course make profits (Bryzgalova & Julliard, 2015). CAPM is also effective in portfolio management as it recognizes that adding a stock to the portfolio increases risk.
WACC
The Weighted Average Cost of Capital (WACC) is a measure used by companies to assess the returns of their investments. Usually, businesses run on borrowed capital, and it is, therefore, important that the cost of capital is assessed as an important parameter. Borrowed funds can either be from listing shares (equity), commercial loans (debt) or from issuing bonds at interests (Ross et al., 2016). WACC determines the average rate at which a company looks forward to paying so as to finance its assets. Debt and equity are the two main variables in this method.
Flotation Costs
Flotation costs are incurred by the companies that are publicly traded. When a company issues new stocks, there are expenses such as legal fees, underwriting fees and registration fees (Bryzgalova & Julliard, 2015). Companies and investors ought to consider how the flotation costs impact on capital. In the calculation of floating costs, companies ought to consider the return on equity, the percentage of the expected earnings and the dividend payments (Ross et al., 2016). Flotation costs inform companies how much, in terms of a percentage that stock issues should be increased by.
Conclusion
In conclusion, it is important that companies determine the actual value of an investment. This is because simple metrics are not true representations of value. Companies could utilize various tools such as Stock Valuation, Total Returns, CAPM, WACC and Flotation Costs. These tools assist in making economically viable decisions especially in the long run.
References
Bryzgalova, S., & Julliard, C. (2015). The consumption risk of bonds and stocks . Stanford University Working Paper.
Ross, S., Westerfield, R., Jaffe, J. & Jordan, B. (2016). Corporate finance (11th edition). New York, N.Y. McGraw-Hill Education.
