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Module 5

The document discusses various valuation concepts and models including return on investment, economic value added, intrinsic bond valuation, dividend discount models, and the capital asset pricing model. Numerical examples are provided to demonstrate calculating intrinsic bond prices, equity values using the dividend discount model and two stage growth model, and economic value added. Key terms defined include NOPAT, WACC, CE, par value, coupon rate, and yield.

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aditi anand
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© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
61 views

Module 5

The document discusses various valuation concepts and models including return on investment, economic value added, intrinsic bond valuation, dividend discount models, and the capital asset pricing model. Numerical examples are provided to demonstrate calculating intrinsic bond prices, equity values using the dividend discount model and two stage growth model, and economic value added. Key terms defined include NOPAT, WACC, CE, par value, coupon rate, and yield.

Uploaded by

aditi anand
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Amity Business School

Valuation Concepts
FIBA601
Amity Business School

• Concept of Valuation
• Return on Investment(ROI),
• Introduction to EVA,
• Calculating EVA
• Economic Value Added &
• Market value added
• Shareholder Value creation
Amity Business School

Valuation of Bonds
and Stocks
Amity Business School

Valuation Concepts

Liquidation Book Value Market Value Intrinsic


value Value
Amity Business School

Intrinsic Value of Bonds


• Par Value
• Coupon rate
• Coupon (amount)= par value*Coupon rate
• Maturity period

𝑃 = 𝐶 ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,𝑛𝑦𝑟𝑠
Amity Business School
Amity Business School

Numerical
• Compute the price of a bond , consider
10yr ,12%coupoun with par value of Rs
1000 and yield of the bond is 13%.

𝑃 = 𝐶 ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,𝑛𝑦𝑟𝑠
Amity Business School

• C = .12*1000= 120
• r = 13%
• M = 1000

𝑃 = 120 ∗ 𝑃𝑉𝐼𝐴𝐹13%,5 𝑦𝑟𝑠 + 1000 ∗ 𝑃𝑉𝐼𝐹13%,5𝑦𝑟𝑠

= 946.1
Amity Business School

• Compute the price of a bond , consider


10yr ,12%coupoun with par value of Rs
1000 and will be redeemed at 10%
premium and yield of the bond is 13%.
Amity Business School

• C = .12*1000= 120
• r = 13%
• M = 1000*1.1= 1100

𝑃 = 120 ∗ 𝑃𝑉𝐼𝐴𝐹13%,5 𝑦𝑟𝑠 + 1100 ∗ 𝑃𝑉𝐼𝐹13%,5𝑦𝑟𝑠

= 976
Amity Business School

• Semi annual bond


𝐶
𝑃 = ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,2𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,2𝑛𝑦𝑟𝑠
2 2 2

• Zero Coupon bond (C=0)

𝑃 = 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,𝑛𝑦𝑟𝑠
Amity Business School

• Consider a 8 year , 12% bond with a par


value of Rs 100 on which interest is paid
semi annually. If the yield of the bond is
14% what is the intrinsic value of the
bond.

𝐶
𝑃 = ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,2𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,2𝑛𝑦𝑟𝑠
2 2 2
Amity Business School

12
𝑃= ∗ 𝑃𝑉𝐼𝐴𝐹14 + 100 ∗ 𝑃𝑉𝐼𝐹14
2 2 %,2∗8𝑦𝑟𝑠 2 %,2∗8𝑦𝑟𝑠

𝑃 = 6 ∗ 𝑃𝑉𝐼𝐴𝐹7%,16𝑦𝑟𝑠 + 100 ∗ 𝑃𝑉𝐼𝐹7%,16𝑦𝑟𝑠

= 90.6
Amity Business School
Amity Business School

Intrinsic Value of Preference Shares


𝑃 = 𝐷 ∗ 𝑃𝑉𝐼𝐴𝐹𝑟𝑝 %,𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟𝑝 %,𝑛𝑦𝑟𝑠

• Compute the value of a preference stock 8


years ,10% with a par value of Rs 1000. The
required return on the preference stock is 9%
Amity Business School

𝑃 = 100 ∗ 𝑃𝑉𝐼𝐴𝐹9%,8𝑦𝑟𝑠 + 1000 ∗ 𝑃𝑉𝐼𝐹9%,8𝑦𝑟𝑠

= 1055.5
Amity Business School

Equity Valuation : Dividend discount model (DDM)

For constant growth model


𝐷1
𝑃0 =
(𝑟 − 𝑔)
Where
𝐷1 = 𝐷0 (1 + 𝑔)
𝐷2 = 𝐷1 (1 + 𝑔)
𝐷2 = 𝐷0 (1 + 𝑔)2
𝐷𝑛 = 𝐷0 (1 + 𝑔)𝑛−1
Amity Business School

Numerical
• Rainbow Engineering Ltd. Is expected to
grow at a rate of 6% per annum. The
dividend expected on company’s equity
share one year hence is Rs 2.What price
will you put on it if the required rate of
return for the share is 14%.
Amity Business School

2
𝑃0 =
(0.14 − 0.06)

= 25
Amity Business School
Amity Business School

Two Stage growth model

(1 + 𝑔1 )𝑛
1− 𝑃𝑛
(1 + 𝑟)𝑛
𝑃0 = 𝐷1 +
𝑟 − 𝑔1 (1 + 𝑟)𝑛
Amity Business School

(1 + 𝑔1 )𝑛
1− 𝐷1 1 + 𝑔1 𝑛−1 (1 + 𝑔2 ) 1
(1 + 𝑟)𝑛
𝑃0 = 𝐷1 + ∗
𝑟 − 𝑔1 𝑟 − 𝑔2 (1 + 𝑟)𝑛
Amity Business School

𝑃0
(1 + 𝑔1 )𝑛 (1 + 𝑔2 )𝑛
1− 1−
(1 + 𝑟)𝑛 𝑛−1 (1 + 𝑟)𝑛
= 𝐷1 + 𝐷1 1 + 𝑔1 (1 + 𝑔2 )
𝑟 − 𝑔1 𝑟 − 𝑔2
𝐷1 1 + 𝑔1 𝑛 (1 + 𝑔2 )(𝑛+𝑚−1) (1 + 𝑔3 ) 1
+ ∗
𝑟 − 𝑔3 (1 + 𝑟)𝑛
Amity Business School

Numerical
The current dividend on an equity share of V Ltd is Rs 2 .
V ltd is expected to enjoy an above normal growth rate of
20% for a period of 6 yrs. Thereafter the growth rate will
fall and stabilize at 10%.Equity investors require a return
of 15%. What is the intrinsic value of the equity shares of
V Ltd
Amity Business School

• 𝑔 1 : 20%

• 𝑔2 : 10%
• n : 6 yrs
• r : 15 yrs
• 𝐷1 : 2(1+.2) = 2.40

(1 + 𝑔1 )𝑛
1− 𝐷1 1 + 𝑔1 𝑛−1 (1 + 𝑔2 ) 1
(1 + 𝑟)𝑛
𝑃0 = 𝐷1 + ∗
𝑟 − 𝑔1 𝑟 − 𝑔2 (1 + 𝑟)𝑛
= 70.76
Amity Business School
H model

𝐷0 1 + 𝑔𝑛 + 𝐻(𝑔𝑎 − 𝑔𝑛 )
𝑃0 =
(𝑟 − 𝑔𝑛 )

H= N
Amity Business School

Numerical
• The current dividend on an equity share of Alpha ltd is
Rs 3.The present growth rate is 50% however it will
linearly decline over a period of 10yrs and stabilize at
12% . What is the intrinsic value of the shares of Alpha
ltd. If the investors require a return of 16%.
Amity Business School

• 𝐷0 : 3
• 𝑔𝑛 : 12%
• 𝑔𝑎 : 50%
• 𝑟 : 16%
• 2H =10yrs
• H : 5 yrs

𝐷0 1 + 𝑔𝑛 + 𝐻(𝑔𝑎 − 𝑔𝑛 )
𝑃0 =
(𝑟 − 𝑔𝑛 )

= 226.5
Amity Business School

P/E ratio approach


𝑃0
𝑃0 = 𝐸1 ∗
𝐸1

𝐷1
𝑃0 =
(𝑟 − 𝑔)

𝐸1 (1 − 𝑏)
𝑃0 =
(𝑟 − 𝑏 ∗ 𝑅𝑂𝐸)
Amity Business School

𝑃0 (1 − 𝑏)
=
𝐸1 (𝑟 − 𝑏 ∗ 𝑅𝑂𝐸)

𝑃0 (1 − 𝑏)
=
𝐸1 (𝑟 − 𝑔)
Amity Business School
Equity Valuation : Capital Asset Pricing
model(CAPM)

CAPM

𝑅𝑖 = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 )𝛽𝑖
Amity Business School

Market Value of Firm

𝑉𝐹 = 𝑉𝐷 + 𝑉𝐸
Amity Business School

Economic Value Added


• Economic Value Added (EVA) is the net
operating profit minus an appropriate charge
for the opportunity cost of all capital invested
in an enterprise or project.
• It is an estimate of true economic profit, or
amount by which earnings exceed or fall short
of the required minimum rate of return
investors could get by investing in other
securities of comparable risk (Stewart, 1990)
Amity Business School
Amity Business School
Numerical

NOPAT 2000000
WACC 10%
CE 750000
Amity Business School

NOPAT 2000000
WACC 10
CE 750000

EVA NOPAT-WACC*CE

1925000
Amity Business School

2014 2015 2016


Capital invested (beginning
of year) $54,236 $50,323 $55,979

WACC 8.22% 8.28% 8.37%

NOPAT $7,265 $5,356 $4,336

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