Introduction to corporate finance Essay Example | Topics and Well Written Essays - 1500 words

Introduction to corporate finance - Essay Example The essential element of such a relationship exists in the significant correlation between prevailing rates of interests and the past changes in the bond prices which are averaged on a weighted basis. This results in the reflection of the effects on the price levels over longer duration of time. (Irving Fisher) Fisher separation is the foundation to the theory of finance. (Moneyterms) This formed the foundation on which the modern day Present Value theories have been established. Fisher's contribution to the theory of finance with respect to the valuation of shares is based on the basis of future earnings and the present value of the earnings on the shares. This paper analyses the propositions on which the share valuation model advocated by Fisher was based and also the newer models that help mitigating the difficulties faced in the Fisher's Model. Fisher attributed the correlation between the prevailing rates of interest and the past changes in the prices of bonds which are averaged using a weighted index, to a not-so-perfect estimation about the expected inflationary tendencies and the resulting intention of the investor to extrapolate the likely future price level changes in the bonds so that the investor may be able to ad... This is known as 'Fisher effect' and is the model that Fisher advocated for use in the valuation of bonds. But it can be observed that the present day analysts use this proposition not only for bond valuation but also for the stocks. In the case of equities it is the forecast of the sustainable growth rate that replicates the interest rate factor of the bond valuation. The 'forecast growth rate' of stocks is the modern day innovation in the financial theory relating to the share valuation and trading. This stand of Fisher was substantiated by Robert F. Wiese. Wiese stated that "the proper price of any security, whether a stock or a bond, is the sum of all the future income payments discounted at the current rate of interest in order to arrive at the present value" John Burr Williams (1938) further describes this theory by stating, "A stock is worth the present value of its future dividends, with future dividends dependent on future earnings. Value thus depends on the distribution rat e for earnings, which rate is itself determined by the reinvestment needs of the business." Propositions of Fisher's Model of Share Valuation The assessment made by Irving Fisher immediately after the crash in the share prices in the year 1929, described the following attributes as determinants of the share price movements in the market, since the share price in the market is determined largely by the discounted value of future earnings in the form of dividends from the respective stock. According to Fisher basically these attributes contribute to the upward changes in the price levels of stocks: (1) "Because the earnings are continually plowed-back into business instead of being declared as dividends" In this statement