Finance Assessing a Potential Investment in Facebook Essay

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 =.....