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Principles of Finance: Unit 6, Valuing an Asset 6 Views


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Valuing an asset…à la Shmoop.

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English Language

Transcript

00:00

principles of finance a la shmoop valuing an asset so how do you value a

00:08

company let us count the ways starting with [Warren Buffet]

00:11

thinking about a home even though that's kind of a different animal and you never [picture of house]

00:15

owned a home it owns you well one way you could in theory value a

00:21

home is to look at the replacement parts of it right you could buy a half acre

00:25

somewhere nearby and simply replicate that same home buying your own timber

00:30

pipes electric wire shingles etc and you'd add up all the costs and your time [building materials]

00:34

labor in the land and all that stuff and say well that's what it cost me to build

00:38

the home that's what it's worth ok that's one way to value it kind of

00:41

the cost to build it alright well another way to value that home is to [construction workers working on a site]

00:44

look at what it cost when it was built but if the home was built like 35 years

00:49

ago is that still relevant like this home here in Palo Alto sells for four

00:54

million dollars it was built 38 years ago and it cost a 200 grand back then so

00:59

yeah a little different so not not that relevant that would be the book value of [very nice expensive home]

01:02

the home sort of but at least the cost of it originally not all that relevant

01:06

there's a third way to value a home it's whatever the market will pay for

01:09

the home yeah good way to value it it's called Zillow just ask your friendly

01:13

neighborhood realtor they know about it Zillow it's kind of an index of [Zillow robot in front of house]

01:17

predictions of what Realtors think and it's adjusted on a per square foot basis

01:21

to what your neighborhood sells for per foot and then acreage adjusted and all

01:26

that crap so zilla's got a good algorithm that does all that and that's [green matrix numbers]

01:29

just kind of what they think the market price will be there's a fourth way to

01:32

value your home if this home will be worth a million dollars in ten years

01:37

what is the most I can pay for it now so that I earn 7.2 percent return on my

01:43

investment all right you're gonna discount that future million dollars ten

01:47

years away to today that number then is the most the home can be worth to you

01:52

the buyer well all of these are at least somewhat reasonable ways of thinking

01:56

about valuing a home but a home doesn't produce cash in fact it consumes it just [water faucet working in reverse]

02:02

wait till your bathtub pipes break when you're a homeowner and you'll feel us [bathtub pipe breaks and floods are]

02:06

big on this one so what if instead of a home we had an apartment building

02:09

aka a stream of cash flows okay that makes it

02:12

a lot easier alright we have 20 apartments in the building which rent [writing on white board]

02:15

for 2 grand a month each that means we're taking in four hundred eighty

02:19

thousand dollars a year right twelve months times forty grand we have

02:23

maintenance and power and water and insurance and other expenses the total

02:26

80 grand a year so we make gross profit of four hundred thousand dollars a year

02:31

from this apartment building well what would you pay to own a hundred percent

02:35

of the equity in this place the it depends answer is always good with us

02:39

here at schmuck can you raise rents over time hmm is the building sellable in ten

02:45

years at a big profit a loss or about the same as where you'll have bought it

02:49

are there regulatory issues like rent control and a bunch of Socialists in the

02:54

government who won't let you do what you want to do with your own investment the

02:57

building is fully rented now 100% will it always be that way or will it be more

03:02

like eighty or seventy two point three all right and then you think about how

03:05

much debt the building could hold so that you have an easier time paying [building turns into a pile of money]

03:09

whatever the current owner dreams that it's worth like when you go to buy it if

03:14

dead on the building is offered by your friendly local bank cost you ten percent [writing on white board]

03:18

a year like they think you're really risky credit and if you paid four

03:22

million dollars for that building well the four hundred grand a year you were

03:26

collecting and operating profits would all go to the bank and just cover the

03:30

interest payments you'd better hope you stay a hundred percent rented during

03:34

this period and that nothing physically goes wrong with the building or well you [apartment building bursts into flames]

03:38

go bankrupt fast but if you could slowly raise rent rates and make more profit [writing on white board]

03:43

while you could eventually pay off that debt and the building then is a nice

03:46

cash flow machine well what if interest rates were only

03:49

five percent instead of ten could you pay eight million dollars and have the [writing on white board]

03:53

same cash flow dynamics as you did in the other scenario well kind of pretty

03:57

much at least from a structural perspective but think about that

04:00

interest rates dropped in half and the notional value of the building just

04:04

almost doubled isn't that crazy how can the building suddenly be worth twice as

04:08

much when one little mothy nugget changes no because it does it is that's

04:13

what happens welcome to the world of interest rates and how powerful they are

04:16

in affecting things like real estate and there's a domino effect that comes with [fingers pushes dominos over]

04:20

it most states tax real estate as a

04:23

percentage of the purchase price so if interest rates

04:26

to go up and real-estate values start to go down well then state taxes start to

04:31

go down in a common ingredient that links all of these potential purchases [hand places cash into cooking pot]

04:35

is the cash that's flowing in the various directions even if you're just

04:39

buying it as an asset with no cash flow like a home eventually you'll want to

04:44

sell it out of profits like buying a growth stock that pays no dividend

04:48

you're gonna buy it hope the asset appreciates one day sell it and that's

04:51

how you kind of do all your math then one day when you sell it in the buyer

04:54

wires cash into your Wells Fargo escrow account well then cash has flowed and if [cash flowing down water slide]

04:59

you want the fancy-schmancy mathy model check out our video on discounted cash

05:03

flow analysis we've got like 18 of them and always remember the phrase cash is

05:07

king because well yes it's good to be king [cash sitting on throne an wearing crown]

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