Equity Valuation

(Free cash flow valuation approach)

Prepared by: WMG 17(Group-3)

1. AMIT GOYAL………………………82004

2. ANKUR SACHDEVA……………….82005

3. GIRISH CHAUDHARY…………….82013

4. KANIKA GUPTA…………………... 82016

5. MONOJEET CHAKRAVORTY…...82024

6. ROHIT RAMAN ……………………82036

7. SHRIKANT RAJU…………………..82078

8. ABHISHEK NAGPAL……………....82085

9. VARUN JAIN………………………..82090
Acknowledgement

We express our sincere gratitude to all those people who have been associated with this
assignment and have helped us with it and made it a worthwhile experience.

Firstly, we express our thanks to Dr. Himanshu Joshi who gave us this opportunity to learn the
subject with such a practical approach. He not only guided us, but also gave us valuable
suggestions and conducted open discussions in the class to help us to understand the various
aspects of Investment market.

We also extend our thanks to our group members who have shared their opinions and
understanding about the topic through which we were able to critically analyze the various
aspects of the report and prepare it.

Finally, we would like to thank the management and the administration team of Fore school of
management with whose efforts and support this executive program has been a success.
Table of Contents

1. Indian Economy Overview

1.1 India GDP growth Rate

1.2 India’s Inflation Rate

1.3 India’s Interest Rate

1.4 India’s current account

1.5 Impact of Budget

2. Industry Analysis
2.1 Indian Telecommunication Industry

2.2 Policies of Telecom Industry in India

2.3 Growth of Telecom Industry in India

3. Company Analysis
3.1(a) About the company – Bharti Airtel

3.1(b) Calculation of FCFF & FCFE

3.2 (a) About the company- Larsen & Toubro

3.2 (b) Calculation of FCFF & FCFE

4. Portfolio Analysis
INDIAN ECONOMY OVERVIEW

1.1 India GDP growth rate

• India Gross Domestic Product (GDP) expanded 6.10% over the last 4 quarters.

• The India Gross Domestic Product is worth 1217 billion dollars or 1.96% of the world economy,
according to the World Bank.

• India's diverse economy encompasses traditional village farming, modern agriculture,

handicrafts, a wide range of modern industries, and a multitude of services. Services are the
major source of economic growth, accounting for more than half of India's output with less than
one third of its labor force.

We know that GDP growth rate of India’s shows declining trend. Main reason behind this is less
rain and global economy meltdown. But in June 2009 GDP rate increases to 6.10 as compare to
march 2009’s 5.8. It shows that India’s GDP rate is increasing. It shows good prospectus for
investors in future. And investor can get benefit by investing in Indian company.

1.2 India’s Inflation Rate

Inflation rate refers to a general rise in prices measured against a standard level of purchasing
power. The most well known measures of Inflation are the CPI which measures consumer prices
index, and the GDP deflator, which measures inflation in the whole of the domestic economy.
India's diverse economy encompasses traditional village farming, modern agriculture,
handicrafts, a wide range of modern industries, and a multitude of services. Services are the
major source of economic growth, accounting for more than half of India's output with less than
one third of its labor force. The economy has posted an average growth rate of more than 7% in
the decade since 1997, reducing poverty by about 10 percentage points.
Interpretation:- As graph shows that inflation rate is rising year by year. Inflation in economy is not
good from investor’s point of view. When inflation rate rises it become the reason of extra costs to
business, thereby squeezing their profit margin and leading to real decline in profitability and there by
reducing the dividends on variable income securities.

1.3 India Interest Rate

India benchmark interest rate stands at 3.25 percent. In India, interest rate decisions are taken by the
Reserve Bank of India's Central Board of Directors. The official interest rate is the benchmark repurchase
rate.

Interpretation: - Data in graph shows that in 2009 interest rate are less than previous year. Means
government is helping the businessmen so that they can continue their business without any difficulty in
economic crisis type of condition by reducing the interest rate. Low interest rate is good from investor’s
point of view.
India Current Account

India Current Account chart, historical data, forecast and news. India is leading exporter of gems and
jewelry, textiles, engineering goods, chemicals, leather manufactures and services. India is poor in oil
resources and is currently heavily dependent on coal and foreign oil imports for its energy needs. Other
imported products are: machinery, gems, fertilizers and chemicals. Main trading partners are European
Union, United States, China and UAE .

Interpretation: - India’s current account shows negative current account. Means import is greater than
export. Investor doesn’t take it positively. As compare to previous year negative balance payment has
increased.

Impact Of Budget On Telecome Industry

• The Finance Minister has announced the allocation of Rs 2,400 crore from the Universal Service
Obligation Fund (USOF) to subsidize mobile, Internet and landline operations in rural India.

• With the government planning to subsidize construction of 11,000 telecom towers across 2.4
lakh villages, the road ahead for the rural sector seems smooth.

• These steps definitely promise greater spending on telecom infrastructure in around 3 lakh
villages which are yet to see the telecom revolution.

• According to budget estimates, for 2009-10, the government expects to collect Rs 48,335.33
crore from the telecom sector, with 3G spectrum sales contributing 75% to the total. In FY 2008-
09, the government's receipts from the sector stood at Rs 13,174.29 crore.
 • The industry is also elated about the CVD exemption on the manufacture of cellphones and
accessories. The industry's happiness did not last long with Pranab Mukherjee announcing the
increase in Minimum Alternate Tax (MAT) from 10% to 15%, which came as a huge blow to the
sector.

• The broadcasting segment can cheer. There is a small decrease in duty for LCD panels from 10%
to 5%, which will bring down prices by a maximum of Rs 3,000 per LCD TV set. LCD TV shipments
that stood at around 1.3 mn units in 2008 are expected to grow in excess of 50% year-on-year as
the preference for flat panel televisions continues to soar amongst Indian viewers.

• However, the industry in general seems happy on the increased spends on robust infrastructure
upgrades and on rural areas, which will possibly add another chapter to the telecom story in
India.

2. Industry Analysis
The purpose of industry analysis is to review prevailing conditions within specific industry and its
segments. The company's industry obviously influences the outlook for the company. Even the best
stocks can post mediocre returns if they are in an industry that is struggling.

“It is often said that a weak stock in a strong industry is preferable to a strong stock in a weak industry.”

To assess the industry group potential, an investor would want to consider the overall growth rate,
market size, and its importance to economy. While the individual company is still important, its industry
group is likely to exert as much as, or more, influence on the stock price. When stock move the usually
move as groups; there are very few lone guns out there. An understanding of the industry sector
involved, including the maturity of the sector and any cyclical effects that the overall economies have on
it, is also necessary.

2.1 Indian Telecommunication industry

Indian Telecommunication industry, with about 464.82 million mobile phone connections (June 2009) ,
is the third largest telecommunication network in the world and the second largest in terms of number
of wireless connections. For the past decade or so, telecommunication activities have gained
momentum in India. Efforts have been made from both governmental and non-governmental platforms
to enhance the infrastructure. The idea is to help modern telecommunication technologies to serve all
segments of India’s culturally diverse society, and to transform it into a country of technologically aware
people.

' Telecom Industry in India ' is regulated by 'Telecom Regulatory Authority of India' (TRAI). It has earned
good reputation for transparency and competence.

Two types of players exists in ' Telecom Industry India ' community –
 • State owned companies like - BSNL and MTNL.

• Private companies like - Reliance Infocomm and Tata Teleservices, Hutchison-Essar, Bharti Tele-
Ventures, Escotel, Idea Cellular, BPL Mobile, Spice Communications etc.

Telecom industry in India has a big market potentiality and is a fast growing sector. Government of India
is eager to reconstitute this telecom industry by enacting effective policies for more investments from
foreign companies, which results in a very competitive and deregulated market in the world.

2.2 Policies of telecom industry in India

Government of India implemented the unified access licensing regime, which enables basic and cellular
mobile service to use any modern technology. In 1997, Telecom Regulatory Authority of India (TRAI) was
formed to facilitate the growth of the telecom sector in India.

Major services and market potentiality of Telecom industry in India

Telecommunication sector in India is primarily subdivided into two segments, which are

• Fixed Service Provider (FSPs) and

• Cellular Services.

Telecom industry in India constitutes some essential telecom services like telephone, radio, television
and Internet.

Telecom industry in India is specifically emphasizing on latest technologies like

• GSM( Global System for Mobile Communications),

• CDMA(Code Division Multiple Access)

• PMRTS(Public Mobile Radio Trunking Services),

• Fixed Line and WLL(Wireless Local Loop ).

2.3 Growth of telecom industry in India

Indian telecom industry continued to register significant growth in 2008-09. Indian telecom network,
with about 414 million connections in February 2009, is the third largest in the world, while it is credited
with the second largest wireless network in the world. At the current pace, the target of 500 million
connections by 2010 is well within reach .The Government of India has reiterated its commitment to
reach out to the remote and uncovered areas and to augment the broadband facilities in rural areas.
 Economic Survey 2008-09 Growth
Growth of Telephone over the years
Mar-06 Mar-07 Mar-08 Mar-09
Fixed Lines 40.23 40.77 39.41 37.73
CDMA 32.67 44.62 68.38 92.14
GSM 69.19 120.47 192.7 283.98
Wireless(GSM&CDMA) 101.86 165.09 261.08 376.12
Gross Total 142.09 205.86 300.49 413.85
Source : Department of Telecommunications point to point

Interpretation :- It shows that India telecom industry is growing in CDMA, GSMA and wireless (CDMA &
GSMA) sectors . It shows overall upward trend of growth rate in these sectors. It will beneficial for
investors to invest in telecom industry. Because it is growing industry. Future prospects are good in this
industry.

3. Company Analysis
3.1 (a) About the company

Bharti Airtel

Bharti Airtel Ltd is a provider of telecommunication services with presence in all the 22 licensed
jurisdictions in India and in Sri Lanka. The company is the largest GSM mobile service provide in India.
The company offers an integrated suite of telecom solutions to enterprise customers, in addition to
providing long distance connectivity both nationally and internationally. The company has fourteen
subsidiary companies. The company provides all the services under the Airtel brand.

The company operates in four strategic business units, namely Mobile, Telemedia, Enterprise and Digital
TV. The mobile business offers services in India, Sri Lanka and Bangladesh. The Telemedia business
provides broadband, IPTV and telephone services in 95 Indian cities. The Digital TV business provides
Direct-to-Home TV services across India. The Enterprise business provides end-to-end telecom solutions
to corporate customers and national and international long distance services to telcos.

The company also provides Passive Infrastructure Services segment, through Bharti Infratel Ltd, which
deploys, owns and manages passive infrastructure in 11 circles of India. The company was ranked
among the six best performing technology companies in the world by Business Week.
3.1( b) Calculation of FCFF & FCFE for Airtel

Assumptions that are used in the calculation

Current Beta 0.7315

terminal growth 0.03

tax_rate 0.2653

r_debt 0.085

risk free rate 0.079

market risk premium 0.08

*figures in Crore Rs.

From the analysis we see that the intrinsic value of each share comes to be Rs. 298.24 and for
FCFE the intrinsic value comes to be Rs 367.54. The market price of the stock is Rs. 322. Hence if
we consider FCFF then the share is over priced and we should sell the stock. Incase we consider
FCFE then we see that the stock is under priced and we should buy the stock.
3.2 Larsen and Toubro
3.2 (a) Company overview—

Company was incorporated on 7th February 1946. Larsen & Toubro carries on business as civil,
mechanical, electrical, chemical & Agricultural engineers as manufacturers as importers & exporters &
as contractors. The Company represents a large number of overseas manufactures, notably
manufacturers of tractors, agricultural machinery, dairy machinery, film cooling towers and general
industrial and engineering plants and coal mining machinery.

Company commissioned a plant at Bangalore for the manufacture of multipurpose hydraulic excavators
and high-pressure hydraulic system in collaboration with Poclain, S.A. France. Company also started
Faridabad Factory for the manufacture of switchboards. Company along with Energy alternative Inc. U S
A., signed a MOU with SAIL for promoting & developing 2 x 250 MW Coal based power plant at Bhilani in
MP in 1994. Also the company tied up with Sargent & Lundy U S A., to offer EPC service for thermal
power projects and also to form a joint venture engineering company. This joint venture would offer
engineering services to power projects in India and abroad. International scale glass container plant
employing the state-of-the art technology was being set up in technical collaboration with Vetropack,
Switzerland. Company also signed of memorandum of intent with Samsung Electronics Co. Ltd. of South
Korea to form a joint venture for the manufacture and marketing of a vide spectrum of telecom
products including large switches, transmission products, paging systems and PABX. Company has
entered into a 50:50 joint venture with Komatsu, Japan, to manufacture hydraulic excavators and
components.

Products & Services—

Engineering & Construction – Projects: L&T's engineering & construction track record consists of
successful implementation of turnkey projects in major core and infrastructure sectors of Indian
industry. L&T has integrated its strengths in process technology, basic and detailed engineering,
equipment fabrication, procurement, project management, erection, construction and commissioning,
to offer single-point responsibility against stringent delivery schedules. Strategic alliances with world
leaders enable L&T to access technical know-how and execute process- intensive large-scale turnkey
projects to maintain its leadership position. L&T's core competencies in engineering include highly
qualified and experienced personnel from various disciplines, state-of-the-art 2-D and 3-D CAD facilities
with sophisticated plant design systems and basic engineering capabilities. L&T is the only Indian EPC
company pre-qualified for executing large, process-intensive projects for oil & gas, refinery,
petrochemical and fertiliser sectors.

Heavy Engineering: L&T is acknowledged as one of the top five fabrication companies in the world, with
engineering and manufacturing capabilities that are among the most sought after in industry. Operating
at the high end of the technological spectrum, L&T has led Indian industry in introducing new processes,
products and materials in manufacturing. L&T also has the logistics capabilities of fabricating and
supplying over-dimensional equipment to tight delivery schedules. L&T's globally benchmarked
workshops are located in Mumbai, Hazira, Baroda and Kansbahal.

Construction: ECC - the Engineering Construction & Contracts Division of L&T is India's largest
construction organization. Many of the country's prized landmarks - its exquisite buildings, tallest
structures, largest industrial projects, longest flyovers, highest viaducts, longest pipelines … have all
been built by L&T. L&T's leading edge capabilities cover every discipline of construction - civil,
mechanical, electrical and instrumentation. L&T has also expanded its focus to the Middle East, South
East Asia, Russia, CIS, Mauritius, African and SAARC countries. L&T is also developing markets for its
construction services in the Indian Ocean rim countries, Africa and Latin America.

Electrical & Electronics: L&T is a major international manufacturer of a wide range of electrical and
electronic products and systems. In the electrical segment, the Company is India's largest manufacturer
of low tension switchgear, and is rapidly establishing itself in international markets. Its products are
widely sold in markets in Europe and Australia. Recently, L&T set up a new manufacturing base for high-
end air circuit breakers in China. L&T also manufactures custom- engineered switchboards for industrial
sectors like power, refineries, petrochemical, cement, etc. In the electronic segment, L&T offers a wide
range of meters and provides complete control and automation systems for diverse industries. Medical
equipment and systems manufactured by L&T include advanced ultrasound scanners and patient
monitoring systems.

Information Technology

Larsen & Toubro Infotech Limited, a 100 per cent subsidiary of L&T, offers comprehensive, end to end
software solutions and services with a focus on Manufacturing, BFSI and Communications & Embedded
Systems. It provides a cost cutting partnership in the realm of offshore outsourcing,application
integration and package implementation. Leveraging the heritage and domain expertise of the parent
company, its services encompass a broad technology spectrum, catering to leading international
companies across the globe. It leverages the L&T parentage to also provide services in the embedded
intelligence and e-Engineering space.

Machinery & Industrial Products: L&T manufactures, markets and provides service support for critical
construction and mining machinery - surface miners, hydraulic excavators, aggregate crushers, loader
backhoes and vibratory compactors.
3.2(b) Calculation of FCFF & FCFE for L & T

Assumptions that are used in the calculation

Current Beta 0.9668

terminal growth 0.05

tax_rate 0.2724

r_debt 0.075

risk free rate 0.079

market risk premium 0.08

FCFF AND FCFE FOR LARSEN & TOUBRO

*figures in Crore Rs.

From the analysis we see that the intrinsic value (FCFF) of each share comes to be Rs. 1013.34 and for
FCFE the intrinsic value comes to be Rs 1198.49. The market price of the stock is Rs. 1930. Hence, in
both the case the share has been over priced and we would suggest to sell the share.
4.0 Portfolio Analysis

Here we have considered the stocks of Airtel and L & T and calculated the return that they give based on
their market prices. Ki and Kj represent the return that they give. The motive of this study is to see if
including one of these stocks in the portfolio reduce the risk on investment.

Ki(Airtel) Pi State of the Economy Kj (L & T) Pj

82 0.6 Strong Growth 52.58 0.6

52.75 0.05 Recession 199.35 0.05

-25.8 0.15 Slow Growth -62.9 0.15

-8.62 0.2 Moderate Growth 116.12 0.2

Here we are considering the probability of return at different stages of the economy at different stages
of economic condition starting to 2007 to 2010.

Step 1
Expected Ki Expected Kj

Ki Pi Ki*Pi Kj Pj Kj*Pj
82 0.6 49.2 52.58 0.6 31.548
52.75 0.05 2.6375 199.35 0.05 9.9675
-25.8 0.15 -3.87 -62.9 0.15 -9.435
-8.62 0.2 -1.724 116.12 0.2 23.224
Expected Ki 46.2435 Expected Kj 55.3045

Step 2

Standard
Deviation
Ki Expected Ki Ki-Eki (ki-Eki)^2 Pi (ki-Eki)^2*Pi
82 46.24 35.76 1278.7776 0.6 767.26656
52.75 46.24 6.51 42.3801 0.05 2.119005
-25.8 46.24 -72.04 5189.7616 0.15 778.46424
-8.62 46.24 -54.86 3009.6196 0.2 601.92392
Variance 2149.773725
Sdi 46.36565243
 Kj Expected Kj Kj-Ekj (Kj-Ekj)^2 Pj (Kj-Ekj)^2*Pj
52.58 55.3 -2.72 7.3984 0.6 4.43904
199.35 55.3 144.05 20750.4025 0.05 1037.520125
-62.9 55.3 -118.2 13971.24 0.15 2095.686
116.12 55.3 60.82 3699.0724 0.2 739.81448
Variance 3877.459645
SDj 62.2692512

Step 3

Effect of portfolio on Return

Ki Wi KJ Wj KiWi+KjWj
82 0.5 52.58 0.5 67.29
52.75 0.5 199.35 0.5 126.05
-25.8 0.5 -62.9 0.5 -44.35
-8.62 0.5 116.12 0.5 53.75

Portfolio Expected Return

Eki Wi Ekj Wj Ekp

46.24 0.5 55.3 0.5 50.77

Here we see that the return with Airtel stock is 46.24 with a risk factor of 46.36 and the range of the
return is from -8.62% to 82%. Whereas L & T stock is giving an expected return of 55.30 with a risk
factor of 62.26 and the returns are ranging from -62.9 to 199.35; that means, if the investor buys all L& T
shares then he will be increasing the return approximately by 19.50% in comparison to Airtel shares but
the risk will also be increased by 35.67%. So the question is what should be the fair strategy to minimize
the risk and maximize the return by opting for a suitable combination of both the shares in the portfolio.
Thus we have assumed that the composition of the stocks in the portfolio is 50 % each. Now we see
what will be the effect on risk and return is by combining these stocks in the portfolio.

Effect of portfolio on SD

SD i Wi SDj Wj SDp
46.36 0.5 62.26 0.5 54.310
Hence We found that , the expected return of the portfolio is coming out to be 50.77 but the risk of the
portfolio is not decreasing as per the return and the range of the weighted return which is coming out
to be from -44.35 to 126.05. The reason behind this is the interaction or the correlation of the two
stocks with each other. Which is calculated as follows:

Step 4
rij 0.4630264
Here rij is the correlation between the expected return of the two stocks considered in the portfolio.

Real Effect of Portfolio on rij = 0.4630

SD
SD i Wi SDj Wj rij SD SDj^2 Wi^2 Wj^2 SDp
i^2
46.36 0.5 62.26 0.5 0.46 2149 3876.31 0.25 0.25 46.586

Here now from the above analysis we see that by combining the two stocks in the portfolio the risk has
decreased to 46.58 from 54.310. The reason for the decrease in the risk is due to the correlation. That
shows the movement in returns of the stock with respect to the other.

Here hence we see that if an investor has this portfolio as compare to a person holding the stock of
Airtel only , would increase the return to 50.77 with almost the same risk i.e 46.58, whereas a person
holding the stock of L & T only , would decrease the risk considerably to 46.586 while giving him a
slightly lesser return i.e 50.77. Hence it will be beneficial to have this kind of portfolio for both the
investors who are willing to invest entirely in either Airtel or L & T.