Valuation of Shares

Question 47
You are requested to find out the approximate dividend payment ratio as to have the
Share Price at ` 56 by using Walter Model, based on following information available
for a Company.
Amount `
Net Profit 50 lakhs
Outstanding 10% Preference Shares 80 lakhs
Number of Equity Shares 5 lakhs
Return on Investment 15%
Cost of Capital (after Tax) (Ke) 12%
(May 17, 5 Marks)
Solution 47
Determine approximate dividend payment ratio by using Walter Model:
r
[E – D]
D ke
P0 = +
ke ke

Where,
P0 = Present worth of Equity share = ₹ 56/-
E = Earning per share (WN: 1) = ₹ 8.4
D = Dividend per share
r = Return on Investment = 15 % or 0.15
Ke = Expected Rate of return to equity shareholder = 12 % or 0.12

WN.1: Earning Per Share (EPS)

Net Profit 50
(-) Preference dividend (80 lakhs X 10 %) (8)
Earning available to equity shares holder 42
() Number of Equity shares 5
EPS ₹ 8.4

Let D = 8.4x
0.15
[8.4 – 8.4 x]
8.4x 0.12
 56 = +
0.12 0.12

56 X 0.12 = 8.4x + 10.5 – 10.5x

6.72 = 2.1x + 10.5
2.1x = 10.5 – 6.72
2.1x = 3.78
x = 1.8

CA Nikhil Jobanputra
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 Incito Academy – Final CA – Strategic Financial Management

 Dividend payout ratio when P0 = 56

1
X 100
84

= 21.4286 % (approx.)

Question 48
Rahim Enterprises is a manufacturer and exporter of woolen garments to European
countries. Their business is expanding day by day and in the previous financial year
the company has registered a 25% growth in export business. The company is in the
process of considering a new investment project. It is an all equity financed company
with 10,00,000 equity shares of face value of ` 50 per share. The current issue price of
this share is ` 125 ex-divided. Annual earning are ` 25 per share and in the absence of
new investments will remain constant in perpetuity. All earnings are distributed at
present. A new investment is available which will cost ` 1,75,00,000 in one year’s time
and will produce annual cash inflows thereafter of ` 50,00,000. Analyse the effect of
the new project on dividend payments and the share price.
(Nov 17, 8 Marks)
Solution 48
1. Analysing the effect of new project on dividend payments:
Current Market Price = ` 125
EPS = Dividend (D0) = ` 25
Dividend
ke = X 100
Current Market Price
25
ke = X 100
125

ke = 20%

If the new project is taken up then dividend amount will get reduced for year 1
and dividend amount will increase from year 2 onwards because of annual cash
inflows from the project.

Dividend for year 1:

` 1,75,00,000
= ` 25 –
10,00,000 Shares

= ` 25 – ` 17.50 = ` 7.5 per share

Dividend for year 2 onwards:

` 50,00,000
= ` 25 +
10,00,000 Shares

= ` 25 + ` 5 = ` 30 per share

Valuation of Shares
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 Incito Academy – Final CA – Strategic Financial Management

2. Analysing the impact of new project on share price:

NPV of Project = PV of Cash – PV of Cash
Inflows Outflows

` 50,00,000
= 20% – ` 1,75,00,000
1 + 0.20 1 + 0.20
` 50,00,000 – ` 1,75,00,000
=
1.20

= ` 62,50,000

Since, NPV of the project is positive, market price of the equity share will increase
by ` 6.25 per share (` 62,50,000/10,00,000 Share)
New Price = ` 125 + ` 6.25 = ` 131.25

Question 49
Goldilocks Ltd. was started a year back with equity capital of ` 40 lakhs. The other
details are as under:
Earnings of the company ` 4,00,000
Price Earnings ratio 12.5
Dividend paid ` 3,20,000
Number of Shares 40,000
Find the current market price of the share. Use Walter's Model.
Find whether the company's D/ P ratio is optimal, use Walter's formula.
(Nov 14, 5 Marks)

Solution 49
1. Determining current market price of share using Walter’s Model:
r
[E – D]
D ke
P0 = +
ke ke

Where
P0 = Current Market price of share
E = Earning per share = ₹ 10/-
D = Dividend per share = ₹ 8/-
R = Return on Investment = 10% or 0.1
Ke = Expected Rate of Return for Equity shareholders = 8% or 0.08

Earnings ₹ 4,00,000
= =
Number of shares 40,000

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 Incito Academy – Final CA – Strategic Financial Management

Dividend Paid ₹ 3,20,000

= =
No. of shares 40,000

Earnings ₹ 4,00,000
= X 100 =
Total Investment 40,00,000
1 1
ke = = = 0.08 or 8 %
P/E Ratio 12.5

0.1
[10 – 8]
 P0 8 0.08
+
= 0.08 0.08

= 100 + 31.25 = ₹ 131.25/-

 Current Market price of share = ₹ 131.25/- per share

2. According to Walter’s Model, when r > ke, value of shares can be maximized by
setting Dividend Payout ratio = 0
Here, the company is paying dividend and hence company’s D/P Ratio is not
optimal.
Calculating P0 when D/P Ratio = 0
0.1
[10 – 0]
0 0.08
 P0 = +
0.08 0.08
 P0 = 0 + 156.25
 P0 = ₹ 156.25

Question 50
The risk free rate of return is 5%. The expected rate of return on the market portfolio
is 11%. The expected rate of growth in dividend of X Ltd. is 8%. The last dividend paid
was ₹ 2.00 per share. The beta of X Ltd. equity stock is 1.5.
1. What is the present price of the equity stock of X Ltd.?
2. How would the price change when?
 The inflation premium increases by 3%
 The expected growth rate decreases by 3% and
 The beta decreases to 1.3.
(May 18, 4 Marks)

Solution
1. Equilibrium price of Equity using CAPM
= 5% + 1.5 (11% – 5%)
= 5% + 9% = 14%
D1 2.00 (1.08) 2.16
P= = = = ₹ 36
Ke – g 0.14 – 0.08 0.06

Valuation of Shares
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 Incito Academy – Final CA – Strategic Financial Management

2. New Equilibrium price of Equity using CAPM (assuming 3% on 5% is inflation

increase)
= 5.15% + 1.3 (11% – 5.15%)
= 5.15% + 7.61% = 12.76%
D1 2.00 (1.05)
P= = = ₹ 27.06
Ke – g 0.1276 – 0.05
Alternatively, it can also be computed as follows, assuming it is 3% in addition to 5%
= 8% + 1.3 (11% – 8%)
= 8% + 3.9% = 11.9%
D1 2.00 (1.05)
P= = = ₹ 30.43
Ke – g 0.119 – 0.05

Alternatively, if all the factors are taken separately then solution of this part will be as
follows:

1. Inflation Premium increase by 3%.

This raises RX to 17%. Hence, new equilibrium price will be:
2.00 (1.08)
= = ₹ 24
0.17 – 0.08
2. Expected Growth rate decrease by 3%.
Hence, revised growth rate stand at 5%:
2.00 (1.05)
= = ₹ 23.33
0.14 – 0.05
3. Hence, revised cost of equity shall be:
= 5% + 1.3 (11% – 5%)
= 5% + 7.8% = 12.8%
As a result, New Equilibrium price shall be
D1 2.00 (1.08)
P= = = ₹ 45
Ke – g 0.128 – 0.08

Question 51
Shares of Volga Ltd. are being quoted at a price-earnings ratio of 8 times. The company
retains 50% of its Earnings Per Share. The Company's EPS is ₹ 10.
You are required to determine:
1. the cost of equity to the company if the market expects a growth rate of 15% p.a.
2. the indicative market price with the same cost of capital and if the anticipated
growth rate is 16% p.a.
3. the market price per share if the company's cost of capital is 20% p.a. and the
anticipated growth rate is 18% p.a.
(Nov 18, 8 Marks)

Solution
1. Cost of Capital
Retained earnings (50%) ` 5 per share

CA Nikhil Jobanputra
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 Incito Academy – Final CA – Strategic Financial Management

Dividend (50%) ` 5 per share

EPS (100%) ` 10 per share (given)
P/E Ratio 8 times (given)
Market price ` 10 X 8 = ` 80 per share
Cost of equity capital
Div
= X 100 + Growth %
Price
`5
= X 100 + 15% = 21.25%
` 80
2. Market Price
Dividend
=
Cost of capital (%) – Growth rate (%)
`5
= = ` 95.24 per share
(21.25 – 16)%

3. Market Price
`5
= = ` 250 per share
(20 – 18)%

Alternatively, if candidates have assumed the given figure of EPS as of last year then
answer will be as follows:
1. Cost of Capital
Retained earnings (50%) ` 5 per share
Dividend (50%) ` 5 per share
EPS (100%) ` 10 per share (given)
P/E Ratio 8 times (given)
Market price ` 10 X 8 = ` 80 per share
Cost of equity capital
Div
= X 100 + Growth %
Price
` 5(1.15)
= X 100 + 15% = 22.19%
` 80

2. Market Price
Dividend
=
Cost of capital (%) – Growth rate (%)
` 5.75
= = ` 92.89 per share
(22.19 – 16)%

3. Market Price
` 5(1.18)
= = ` 295 per share
(20 – 18)%

Valuation of Shares
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 Incito Academy – Final CA – Strategic Financial Management

Question 52
The shares of G Ltd. we currently being traded at ` 46. The company published its
results for the year ended 31st March 2019 and declared a dividend of ` 5. The
company made a return of 15% on its capital and expects that to be the norm in which
it operates. G Ltd. Also expects the dividends to grow at 10% for the first three years
and thereafter at 5%. You are required to advise whether the share of the company is
being traded at a premium or discount.
PVIF @ 15% for the next 3 years is 0.870, 0.756 and 0.658 respectively.
(May 19, 8 Marks)

Solution
Expected dividend for next three years
Year 1 (D1) = 5 (1.1) = 5.5
Year 2 (D2) = 5.5 (1.1) = 6.05
Year 3 (D3) = 6.05 (1.1) = 6.655
Required Rate (Ke) = 15%
Present Value of Dividends = 5.5 (0.870) + 6.05 (0.756) + 6.655 (0.658)
= 4.785 + 4.574 + 4.379 = 13.74
Now, PV at growth rate of 5%
D4 6.655(1.05) 6.988
P3 = = = = 69.88
Ke – g 0.15 – 0.05 0.1

Therefore, P0 = 69.88 x 0.658 = 45.98

Now, adding the PV of dividend at two different growth rates, we get,
13.74 + 45.98 = 59.72
Hence, it is clear that shares are being traded at discount i.e. undervalued because
intrinsic value of share is more than the market price.

Question 53
ABB Ltd. has a surplus cash balance of ` 180 lakhs and wants to distribute 50% of it to
the equity shareholders. The company decides to buyback equity shares. The
company estimates that its equity share price after re–purchase is likely to be 15%
above the buyback price. if the buyback route is taken.
Other information is as under:
1. Number of equity shares outstanding at present (Face value ` 10 each) is ` 20
lakhs.
2. The current EPS is ` 5.

You are required to calculate the following:

1. The price at which the equity shares can be re–purchased, if market capitalization
of the company should be ` 400 lakhs after buy back.
2. Number of equity shares that can be re – purchased.
3. The impact of equity shares re–purchase on the EPS, assuming that the net income
remains unchanged.
(May 19, 8 Marks)
CA Nikhil Jobanputra
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 Incito Academy – Final CA – Strategic Financial Management

Solution
1. Let P be the buyback price decided by ABB Ltd.
Market Capitalisation after Buyback
400 lakhs = 1.15P (Original Shares – Shares Bought Back)
50% of 180 Lakhs
= 1.15P 20 Lakhs –
P
= 23 Lakhs X P – 90 Lakhs X 1.15
= 23 Lakhs P – 130.50 Lakhs
= Again, 23 Lakhs P – 130.50 Lakhs
Or 23 Lakhs P = 400 Lakhs + 130.50 Lakhs
503.50
Or P = = 21.89 per Share
23

2. Number of Shares to be Bought Back:

` 90 lakhs
= 4.111 lakhs (Approx.) or 411147 shares
21.89

3. Shares after buyback

= 20 lakhs – 4.111 lakhs = 15.889 lakhs
Or 20,00,000 – 4,11,147 = 15,88,853 shares
5 X 20 lakhs
∴ EPS = = ` 6.29
15.889 lakhs
Thus, EPS of ABB Ltd., increases to ` 6.29.
So, EPS of ABB Ltd. is increased by ` 1.29 (6.29 – 5.00)

Question 54
Following financial information’s are available of XP Ltd. for the year 2018:
Equity Share Capital (` 10 each) ` 200 Lakh
Reserves and Surplus ` 600 Lakh
10% Debentures (` 100 each) ` 350 Lakh
Total Assets ` 1200 Lakh
Assets Turnover Ratio 2 times
Tax Rate 30%
Operating Margin 10%
Dividend Payout Ratio 20%
Current Market Price per Equity Share ` 28
Required Rate of Return of Investors 18%

You are required to:

1. Prepare Income Statement for the year 2018.
2. Determine its Sustainable Growth Rate.
3. Determine the fair price of the company's share using Dividend Discount Model.
4. Give your opinion on investment in the company's share at current price.
(May 19, 8 Marks)

Valuation of Shares
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 Incito Academy – Final CA – Strategic Financial Management

Solution
Workings:
Asset turnover ratio = 2 times
Total Assets = ` 1,200 Lakh
Turnover ` 1200 lakhs X 2 = ` 2,400 lakhs
Interest on Debentures = 350 lakh X 10% = 35 lakhs
Operating Margin = 10%
Hence operating cost = (1 – 0.10) 2,400 lakhs = ` 2,160 lakhs
Dividend Payout = 20%
Tax Rate = 30%

1. Income statement
(` Lakhs)
Sale 2,400
Operating Exp 2,160
EBIT 240
Interest 35
EBT 205
Tax @ 30% 61.5
EAT 143.5
Dividend @ 20% 28..7
Retained Earnings 114.8

2.
SGR = Return on Equity (1 – Dividend Payout Ratio)
= ROE (1 – b)

PAT and NW = ` 200 lakhs + ` 600 lakhs

ROE =
NM = ` 800 lakhs
`. 143.5 Lakhs
ROE = X 100 = 17.94%
` 800 Lakhs
SGR = 0.1794 (1 – 0.20) = 14.35%
0.1794 X 0.80 0.14352
or = = 16.76%
1 – 0.1794 X 0.80 0.85648
3. Calculation of fair price of share using dividend discount model
D0 (1 + g)
P0 =
Ke – g
` 28.7 Lakhs
Dividends = = 1.435
20 Lakhs
Growth
= 14.35% or 16.76%
Rate
Hence P0 = 1.435 (1 + 1.435) = ` 1.64 = ` 44.93 or 44.96
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 Incito Academy – Final CA – Strategic Financial Management

0.18 – 0.1435 0.0365

1.435 (1 + 0.1676) ` 1.676
OR = = ` 135.16 or 135.12
0.18 – 0. 1676 0.0124

4. Since the current market price of share is ` 28, the share is undervalued. Hence,
the investor should invest in the company.

Question 55
Following information is available of M/s. TS Ltd.
(` in Crores)
PBIT 5.00
Less: Interest on Debt (10%) 1.00
PBT 4.00
Less: Tax @ 25% 1.00
PAT 3.00
No. of outstanding shares of ` 10 each 40 Lakhs
EPS (`) 7.5
Market price of share (`) 75
P/E Ratio 10 Times
TS Ltd. has an undistributed reserve of ` 8 crores. The company required ` 3 crores
for the purpose of purpose of expansion which is expected to earn the same rate of
return on capital employed as present. However, if the debt to capital employed ratio
is higher than 35%, then P/E ratio is expected to decline to 8 Times and rise in the cost
of addition debt to 14%. Given this data which of the following options the company
would prefer, and why?

Option i. If the required amount is raised through debt

Option ii. If the required amount is raised through equity and the new shares be
issued at a price of ` 25 each.
(Nov 19, 8 Marks)

Solution
Working Notes
1. Calculation of Return on Capital Employed (ROCE)
(` in crores)
Capital Employed:
Share Capital (` 10 X 40 lakhs) 4
Reserves 8
Debt (` 1 cr. X 100/10) 10
22
PBIT 5
ROCE 22.73%

2. Revised PBIT

Valuation of Shares
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 Incito Academy – Final CA – Strategic Financial Management

Existing Capital Employed 22

Additional 3
ROI 22.73%
Revised PBIT 5.6825

3. New Debt/Equity
Existing Debt 10
Additional Under Option (i) 3
Total Debt 13
Total Equity 12
New Debt to Capital Employed Ratio
13
= = 0.52
25

So, P/E Ratio to be reduced to 8 times

4. Debt to Capital Employed Ratio in Option (ii)

10
= = 0.40
25
So, P/E Ratio to be reduced to 8 times in this case also

5. Number of additional shares to be issued in case of Option (ii)

Funds to be raised ` 3 crore
Price per share ` 25
New Debt to Capital Employed Ratio
` 3 crore
= = 12 lakhs
` 25

Particulars Option (i) Option (ii)

PBIT (Revised) (` Crore) 5.6825 5.6825
Less: Interest on Debt 1.42 1.00
PBT (` Crore) 4.2625 4.6825
Tax @ 25% (` Crore) 1.0656 1.1706
PAT (` Crore) 3.1969 3.5119
No. of shares outstanding 40 lakhs 52 lakhs
EPS ` 7.99 ` 6.75
P/E Ratio 8 8
New Share Price ` 63.92 ` 54.00

Decision:
Since the MPS is expected to be more in the case of additional financing done through
debt (Option – I) Option – I is preferred.

CA Nikhil Jobanputra
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 Incito Academy – Final CA – Strategic Financial Management

Question 56
Mr. X, a financial analyst, intends to value the business of PQR Ltd. in terms of the
future cash generating capacity. He has projected the following after tax cash flows:
Year 1 2 3 4 5
Cashflow (` in lakh) 1,760 480 640 860 1,170

It is further estimated that beyond 5th year, cash flows will perpetuate at a constant
growth rate of 8% per annum, mainly on account of inflation. The perpetual cash flow
is estimated to be ` 10,260 lakh at the end of the 5th year.

Required:
1. What is the value of the firm in terms of accepted future cash flow? If the cost of
capital of the firm is 20%.
2. The firm has outstanding debts of ` 3620 lakh and cash / bank balance of ` 2710
lakhs.

Calculate the shareholder value per share if the number of is outstanding share is
151.50 lakhs.
1. The firm has received a take over bid from XYZ Ltd. of ` 225 per share. Is it a good
offer?
(Given: PVIF at 20% for year 1 to year 5: 0.833, 0.694, 0.579, 0.482, 0.402)
(Nov 19, 8 Marks)

Solution
1. Value of firm
Year Cash Flow (` in lakhs) PVF PV (` in lakhs)
1 1,760 0.833 1,466.08
2 480 0.694 333.12
3 640 0.579 370.56
4 860 0.482 414.52
5 1,170 0.402 470.34
PV of Cash flows upto year 5 3,054.62
If PV of Terminal Value is considered with the growth rate (at the end of 5th year)
10,260 (1+ 0.08) 11,080,80
= = = ` 92,340 lakh
0.20 – 0.08 0.12

Now, PV (at the beginning of the year)

= ` 92,340 X 0.402
= ` 37,120.68 Lakhs

So, Present Value of the firm

= ` 3,054.62 + ` 37,120.68
= ` 40,175.30 Lakhs

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 Incito Academy – Final CA – Strategic Financial Management

2. Value per share

Value of Firm – Value of Debt
=
No of shares
40,175.30 – 3,620
=
151.50
= ` 241.29

3. Takeover bid of ` 225 per share seems to be not a good offer as it is lesser than the
intrinsic value i.e. value per share of ` 241.29.

CA Nikhil Jobanputra
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