The selected company for bond analysis and valuation is Accenture Plc (Accenture), which is a leading computer and accessories manufacturing company. The evaluation of a bond offered by the selected company that will pay $100,000 in a year’s time is carried out on the basis of the inclusion of various factors in the assessment that can affect the bond’s yield to maturity. In addition, this analysis paper considers two other companies including Hewlett-Packard and IBM that are direct competitors of Accenture and also perform their bond evaluation.
Bond pricing depends on different risk factors that affect the term structure of interest rates. These could include inflation, T-bill rates, central bank lending rates, etc. Furthermore, there are other factors such as the company’s default risk, profit margin, stock’s beta, and liquidity position. These factors affect the credit rating of a company. In order to consider the price that I would be willing to pay for a $100,000 bond of HP, I would consider all these factors. I am a risk-averse investor who prefers low risk in his portfolio and would accept a low price for a bond. The reason for accepting a low price for a bond is my expectation that the amount to be received at maturity will not have the same value as the money at present.
The inflation rate in the US hovered between 1.5% and 2.0% in the last year. However, analysts suggest that the inflation rate is likely to increase in the US (Mutikani, 2014). This means that investors would require a higher return on their investment in order to cover the high inflation rate. This would lower the price of the bond. By considering the Federal Funds Rate, it is expected that the Federal Reserve Bank would increase its interest rates in Spring 2015. This rate has a direct influence on the LIBOR benchmark, which is widely used by banks for costing of their loans and bonds. Moreover, the 10-Year US Treasury Bill rate went up from 1.66% in May 2013 to 3.04% in December 2013 (Mahn, 2014).
A high-interest rate implies a decrease in the price of the bond. In the last three years, the company’s sales declined. The company’s sales and net profits increased in the last three years (Accenture plc (ACN), 2014). This suggested that the company faced fewer difficulties related to its business. Moreover, its stock beta was 1.22 (Accenture plc (ACN), 2014), which suggested that the company’s stock price fluctuated more than the changes in the market index (S&P500). Keeping in view, these factors, I would pay a low price for the company’s one-year bond. The price for the one-year bond that I would pay is $90,000. The discount would cover the inflation rate, interest rate on T-bill, and riskiness of the company to pay back its borrowed amount.
Based on the price i.e. the present value of the bond that I would be willing to pay for the one-year bond, the discount rate can be calculated as follows.
Period = 1 Year
Future Value = $100,000
Coupon = 0%
Present Value = PV = $92,000
Discount Rate = r = (FV / PV)-n-1 (Parameswaran, 2007)
r = 8.70%
The discount rate is 8.70%. The discount rate refers to the rate which makes the present value of a financial instrument equal its future value ($92,000*(1+8.70%).
For the purpose of bond valuation, two other companies were selected as IBM and HP. The financial analysis included in Appendix indicates key financial ratios and beta values of each of the three companies operating in the same industry. The bond valuation is based on the assessment of different factors affecting the pricing decision.
From the financial analysis, it could be indicated that IBM had the highest total debt / total equity ratio value (International Business Machines Corporation (IBM), 2014). This could be a major concern for shareholders and debtholders. A higher ratio value implied a greater risk of default, which could lower the price the investor would be willing to pay for the company’s bond. Moreover, the debt ratio value of HP was 2.88, which suggested a high risk associated with the repayment of debt. Based on the profitability analysis, it could be indicated that IBM outperformed both Accenture and HP in 2013.
The worst performer in terms of liquidity and profitability was HP which also incurred a huge loss in 2012. The finding also suggested that HP faced major problems in recent years and its market position had been adversely affected by its poor financial performance (Hewlett-Packard Company (HPQ), 2014). The low profitability and liquidity of HP implied that the investor would consider high risks associated with the company and would pay a low price for the company’s bond.
The beta of IBM was 0.68 as compared to 1.22 of Accenture and 1.77 of HP. A beta value of more than one suggests the high riskiness of the company’s stock and also the high cost of equity based on CAPM. It also suggested that the investor would pay a lower price for the company’s bond with high riskiness.
On the basis of the evaluation of different risk factors, it could be suggested that the investor would be willing to pay a high price for IBM and a low price for HP as compared to a $100,000 bond issued by Accenture.
References
Accenture plc (ACN). (2014). Web.
Hewlett-Packard Company (HPQ). (2014). Web.
International Business Machines Corporation (IBM). (2014). Web.
Mahn, K. (2014). Fed On Target To Raise Interest Rates In Spring 2015. Web.
Mutikani, L. (2014). Rising food, housing costs push up U.S. inflation. Web.
Parameswaran, S. (2007). Bond Valuation, Yield Measures and the Term Structure. New Delhi: Tata McGraw-Hill Education.
Appendix
Yield to Maturity (%).