Scribd
Upload
31 views4 pages

Assignment No 1 MGT 201

The document analyzes two investment options: shares of M&J Textiles and bonds of Dhani Textiles. It calculates the intrinsic value of each and finds the shares are undervalued and bonds overvalued. For a risk-averse investor, bonds are safer though overpriced, and shares carry more risk but offer potential for higher returns due to being undervalued.

Uploaded by

affanmuneer
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
31 views4 pages

Assignment No 1 MGT 201

The document analyzes two investment options: shares of M&J Textiles and bonds of Dhani Textiles. It calculates the intrinsic value of each and finds the shares are undervalued and bonds overvalued. For a risk-averse investor, bonds are safer though overpriced, and shares carry more risk but offer potential for higher returns due to being undervalued.

Uploaded by

affanmuneer
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 4

Assignment No 1

MGT 201
Financial Management
BC220413605
Calculate intrinsic value of both investment options and identify whether these
securities are undervalued or over-valued.

Solution:

Option 1: Shares of M&J Textiles

Given:

Face Value = Rs. 100

Dividend (D0) = Rs. 10

Dividend Growth Rate for first 3 years (g1) = 6%

Dividend Growth Rate after 3 years (g2) = 8%

Market Interest Rate (r) = 15%

Current Market Price = Rs. 98

1. First Stage (Years 1 to 3):

D1 = D0 × (1 + g1) = 10 × (1 + 0.06) = Rs. 10.60

D2 = D1 × (1 + g1) = 10.60 × (1 + 0.06) = Rs. 11.24

D3 = D2 × (1 + g1) = 11.24 × (1 + 0.06) = Rs. 11.91

2. Second Stage (Year 4 onward):

D4 = D3 × (1 + g2) = 11.91 × (1 + 0.08) = Rs. 12.86

The present value of dividends for years 1, 2, and 3:

𝑃𝑉(𝐷1) = = = 𝑅𝑠.9.22

𝑃𝑉(𝐷2) = = = 𝑅𝑠.8.50
𝑃𝑉(𝐷3) = = = 𝑅𝑠.7.83

3. Terminal Value (from year 4 onward):

The terminal value at year 3 (TV3) is calculated using the Gordon Growth Model:

𝑇𝑉3 = = = = 𝑅𝑠.183.71

The present value of the terminal value:

𝑃𝑉(𝑇𝑉3) = = = 𝑅𝑠.120.82

4. Total Present Value of Dividends:

𝑃𝑉(𝐷1) + 𝑃𝑉(𝐷2) + 𝑃𝑉(𝐷3) + 𝑃𝑉(𝑇𝑉3) = 9.22 + 8.50 + 7.83 + 120.82 = 𝑅𝑠.146.37

Therefore, the intrinsic value of M&J Textiles' shares is Rs. 146.37. Since the current market
price is Rs. 98, the shares are undervalued.

Option 2: 10-year Bonds of Dhani Textiles

Given:

Face Value = Rs. 1000

Annual Coupon (C) = 12% of 1000 = Rs. 120

Market Interest Rate (r) = 15%

Current Market Price = Rs. 980

The intrinsic value of a bond is calculated by discounting the coupon payments and the face
value back to the present value at the market interest rate.

1. Present Value of Coupons:

𝑃𝑉(𝐶𝑜𝑢𝑝𝑜𝑛𝑠) = 120 = 120


Using a financial calculator or Excel, this can be simplified to:

𝑃𝑉(𝐶𝑜𝑢𝑝𝑜𝑛𝑠) = 120×5.0188 = 𝑅𝑠.602.26

2. Present Value of Face Value:

𝑃𝑉(𝐹𝑎𝑐𝑒𝑉𝑎𝑙𝑢𝑒) = = = 𝑅𝑠.247.18

3. Total Present Value:

𝑃𝑉(𝑇𝑜𝑡𝑎𝑙) = 𝑃𝑉(𝐶𝑜𝑢𝑝𝑜𝑛𝑠) + 𝑃𝑉(𝐹𝑎𝑐𝑒𝑉𝑎𝑙𝑢𝑒)

𝑃𝑉(𝑇𝑜𝑡𝑎𝑙) = 602.26 + 247.18 = 𝑅𝑠.849.44

Therefore, the intrinsic value of Dhani Textiles' bonds is Rs. 849.44. Since the current market
price is Rs. 980, the bonds are overvalued.

1. Suggest which investment option Aneela should select if she declares herself as a
risk- averse investor, will it be a rational decision based on intrinsic value
comparison in question 1, why or why not?

Solution:

Risk-Averse Investor Analysis


Aneela has declared herself as a risk-averse investor. For a risk-averse investor, the primary goal
is to minimize risk, even if it means accepting lower returns.

1. Comparison Based on Intrinsic Value:

 M&J Textiles' shares: Intrinsic value = Rs. 146.37, Market price = Rs. 98 (undervalued)
 Dhani Textiles' bonds: Intrinsic value = Rs. 849.44, Market price = Rs. 980 (overvalued)

2. Rational Decision: Compared to Dhani Textiles' overpriced bonds, M&J Textiles' shares
are more appealing due to their undervaluation from an intrinsic value perspective. But
because of their inherent volatility, stocks are often riskier than bonds. Despite the
pricing, Aneela's risk aversion makes investing in discounted equities riskier than bonds.
Conclusion
Bonds are a safer investment option for Aneela, who is a risk-averse investor. It may not be a
wise choice to buy in Dhani Textiles' bonds, nevertheless, since they are currently overpriced.
She may be justified in investing in the cheap shares of M&J Textiles if she is ready to accept a
little risk in the hopes of potentially bigger profits. If she isn't comfortable with this level of risk,
she should seek out other bond choices or more conservative investing possibilities.

You might also like