Doubling period.

Mr. X deposits Rs.10,000 on 1st Jan 2019 at 10% rate of interest. How
many years will it take to double this amount? Work out this problem by
using

a. Rule of 72
b. Rule of 69.

Solution:

a. Rule of 72
72
Doubling period =
Rate of interest
72
Doubling period = = 7.2 years
10

b. Rule of 69
69
Doubling period = 0.35 +
Rate of interest
69
Doubling period = 0.35 + = 0.35+6.9 = 7.25 years
10

Valuation of Debentures and bonds and Equity shares

Based on the knowledge of financial Arthamatics we can evaluate the

securities either to buy or not to buy. The Compounding and discounting
technique helps the person to calculate both future as well as present
value of each securities or bonds.

It is divided into redeemable and irredeemable bonds/ debentures.

Valuation of redeemable bonds/ Debentures

PVB = I1/(1+d)1 + I2 /(1+d)2 + I3 /(1+d)3 +I4/(1+d)4 + I5/(1+d)5 + M /(1+d)5

PVB = Present value of BOND

I= Interest amount received

d = the discount rate/ Capitalization rate

n = no of years
Problems.

1. What is the Present value of a bond if it matures after four years

and yield Rs 60 every year with a maturity value of Rs 110 and If
the capitalization rate is 8 percent.
PVB = I1/(1+d)1 + I2 /(1+d)2 + I3 /(1+d)3 +I4/(1+d)4 + M4 /(1+r)4

PV of the Bond = 60 /(1+0.08)1 + 60 /(1+0.08)2 + 60/(1+0.08)3 +

60/(1+0.08)4 + 110 /(1+0.08)4
= 60 /(1.08)1 + 60 /(1.08)2 + 60/(1.08)3 + 60/(1.08)4 + 110 /(1.08)4
= 60 / 1.08 + 60/1.1664 + 60/1.2597 + 60/1.3604 + 110 / 1.3604
= 56 + 51 + 48 + 44 + 81
= 280

2. A debenture is available in the market for Rs 1000, with Rs 80 as

the Interest for a year for a period of four years with the maturity
value of Rs 1,120 . The debenture capitalization rate is 10 %
.Advice Mr pavan I his buying decision of this debenture.

PVB = I1/(1+d)1 + I2 /(1+d)2 + I3 /(1+d)3 +I4/(1+d)4 + I5/(1+d)5 + M

/(1+d)5
PV of the Bond = 80 /(1.1)1 + 80 /(1.1)2 + 80/(1.1)3 + 80/(1.1)4 +
1120 /(1.1)4
= 72 + 66 + 60 + 55 + 765
PV of the bond = 1019

3. A bond is available for 1000 . it has interest amount of Rs 80 per

year for a period of five years with the capitalization rate of 12
percent. The bond has the maturity value of Rs 1140. Advise the
investor in his buying decision.

PVB = I1/(1+d)1 + I2 /(1+d)2 + I3 /(1+d)3 +I4/(1+d)4 + I5/(1+d)5 + M5

/(1+r)5

PVB = 935

Valuation of Irredeemable bond or debenture

PVD = I / d

1. What is the value of irredeemable debenture which has Rs.60 as the

interest for an infinite period which the discount rate at 9%

PVD = I / d

= 60 / 0.09 = 667

2. How much an investor has to pay for the following debt instrument
which gives the interest per year is Rs.70 and its capitalization rate is 11%

636

3. What is the value of bond which has an indefinite period with the
interest amount of Rs.50 per year with the capitalization rate of 9%

556

Valuation of Irredeemable preference shares

PVIPS = D / d

D = Dividend

d = Capitalization rate

1. A company issued 8% irredeemable preference share of Rs.100

each. The capitalization rate is 6%. Compute the present value of
preference shares.

Dividend = Rs.100 x 8% = Rs.8

PVIPS = 8 / 0.06 = 133

2. Calculate the present value of 9% irredeemable preference share

of Rs.100 each with capitalization rate of 7%
 Rs. 129

3. Compute the present value of 7% irredeemable preference share

of Rs.100 each if its capitalization rate is 11%

64

Valuation of Equity Shares

The value of equity share are determined by suing two approaches

1. Dividend capitalization Model

2. Earnings capitalization Model

Dividend Capitalization Model

a. Single period valuation Model

𝐷1 𝑃1
PVES = (1+𝑑) 1 + (1+𝑑)1

D = Dividend paid in the first year

P1 = Price of the equity share at the end of the 1st year

d = Discount or capitalization rate

1. Mr. Raghu holds an equity share which has the feature of

getting Rs.20 as the dividend for the first year. He expects to
sell the same share for Rs.190 at the end of the year. What is
the value today if capitalization rate is 11%.
𝐷1 𝑃1
PVES = (1+𝑑) 1 + (1+𝑑)1

D1 = Dividend = Rs.20

d=capitalization rate = 11% = 0.11

PVES = (1+20.11)1 + (1+.11)

190
1 = 18 +171
PVES = 189

2. Mr. Anand is planning to buy an equity share, hold it for

one year and then sell it. The expected dividend at the end
of the year is Rs.8 and the expected sale proceeds Rs. 220
after the first year. Determine the value of equity share if
the capitalization rate is 14%.

PVES = (1+ 8.14)1 + (1+.14)

220
1 = 7 +193

PVES = 200

3. Mr. Raj is holding an Equity share which has the following features:

a. The current dividend for the 1st year is Rs.10

b. The sale price of the equity share is Rs.140

c. The discount rate of today is 12%.

Calculate the today value of equity share.

PVES = (1+10.12)1 + (1+.12)

140
1 = Rs. 134

Two Period Valuation model (holding the shares for two years)
𝐷1 𝐷2 𝑃2
PVES = (1+𝑑) 1 + (1+𝑑)2 + (1+𝑑)2

D1= Dividend paid in the first year

D2= Dividend paid in the second year

P2 = Price of the equity share at the end of the 2nd year

d = Discount or capitalization rate

4. Mr. Naresh is holding the equity share of a company which has the following features

a. The dividend of 1st year and 2nd year of the company is Rs.8 and Rs.10

b. The discount rate applicable is 9%

c. The sale price of the equity share at the end of the 2nd year is 160

Calculate the present value of equity share.

𝐷1 𝐷2 𝑃2
PVES = (1+𝑑) 1 + (1+𝑑)2 + (1+𝑑)2 = 7+8+135 = 150

5. Mr. Ramesh hold an equity share which has the dividend of Rs.7, Rs.8 and Rs.10 for first 3
years. The equity capitalization rate is 12%. He desires to sell the equity share for Rs. 240.
What is present value today?
𝐷1 𝐷2 𝐷3 𝑃3
PVES = (1+𝑑) 1 + (1+𝑑)2 + (1+𝑑)3 + (1+𝑑)3 = 6.25 + 6 + 7 +171 = 190

When the dividend is growing at constant rate

𝐷
PVES = 𝑑−𝑔

D = dividend

d=discount rate / capitalization rate

g = growth rate of dividend

1. A company is expected to pay a dividend of Rs.8 per share by next

year. The dividend is expected to grow continuously at the rate of 10%.
What is the value of the equity share if the required rate of return is 12%
𝐷
PVES = 𝑑−𝑔
8
PVES = .12−.10 = Rs. 400

2. ABC Company is expected to pay a dividend at Rs.50 per share.

Dividend is expected to grow perpetually at 11%. Calculate the present
value of the equity share if the capitalization rate is 16%
50
PVES = .16−.11 = Rs. 1000
3. An investor is contemplating to purchase an equity share which has
the following features

a. The current dividend is Rs.30

b. The discount rate applicable 16%

c. The growth rate of the dividend is 8%

What is its value today?

30
PVES = .16−.08 = Rs. 375

When the dividend is growing at variable rate

A company is expected to pay a dividend of Rs.5 per share after a year. Its dividends are
expected to grow at 14% for next 5 years and then at the rate of 7% indefinitely. Find out the
present value of the share if the capitalization rate is 11%.

Pv factor @11 is

1 yr 2nd yr 3rd yr 4th yr 5th yr 6th yr

0.900 0.811 0.731 0.659 0.593 0.535

Step 1: calculation of pv of dividend

Year Growth dividend

1 5
2nd =5 + (5 * 14%) =5+0.7 5.70
3rd = 5.7 + (5.7 x 14%) = 5.7 +.80 6.50
4th = 6.50 + (6.50 x 14%) = 6.50 + 0.9 7.40
5th = 7.40 + (7.40 x 14%) = 7.40+1.00 8.40
6th = 8.40 + (8.40 x 14%) = 8.40+1.2 9.60

Convert into present value

𝐷1 𝐷2 𝐷3 𝐷4 𝐷5 𝐷6
= (1+𝑑) 1 + (1+𝑑)2 + (1+𝑑)3 + (1+𝑑)4 + (1+𝑑)5 + (1+𝑑)6

5 5.70 6.50 7.40 8.40 9.60

= (1.11)1 + (1.11)2 + (1.11)3 + (1.11)4 + (1.11)5 + (1.11)6 = 28.85
Or

If the pv factor is given

Year Growth dividend PV PV

(dividend x pv
factor factor)
1 5 0.900 4.50
2nd =5 + (5 * 14%) =5+0.7 5.70 0.811 4.62
3rd = 5.7 + (5.7 x 14%) = 5.7 +.80 6.50 0.731 4.75
4th = 6.50 + (6.50 x 14%) = 6.50 + 7.40 0.659 4.88
0.9
5th = 7.40 + (7.40 x 14%) = 8.40 0.593 4.98
7.40+1.00
6th = 8.40 + (8.40 x 14%) = 8.40+1.2 9.60 0.535 5.13
Total 28.85

Step 2 : Find out the present value of equity share at the end of the year
with the constant growth in dividend

Dividend in the 7th year = 9.60 + (9.60x7%) = 10.27

If the dividend growth rate is 7% (consider)

𝐷 10.27
PVES = 𝑑−𝑔 =
.11−.07
= 256

Convert it into todays value by multiplying the PV factor @11% of 6th year

256.75 x 0.535 = 137.36 (we have taken under 7% growth rate)

Step 3:

Present value of equity = Present value at 7% + present at 14%

= 137.36 + 28.85

= 166.21
 3. A company is expected to pay a dividend of Rs.6 per share after a year. Its
dividends are expected to grow at 14% for next five years and then at the rate
9% for ever. Find out the present value of its share, if the capitalization rate is
13%.

Step 1: calculation of pv of dividend

Year Growth dividend PV factor @13% PV

1/(1+0.13)n
1 6 0.885 5.31
2nd +14% 6.84 0.783 5.35
3rd +14% 7.79 0.693 5.40
4th +14% 8.88 0.613 5.44
5th +14% 10.12 0.543 5.49
6th +14% 11.55 0.480 5.53
32.51

Step 2 : Find out the present value of equity share at the end of the year
with the constant growth in dividend

Dividend in the 7th year = 11.55 + (11.55 x9%) = 12.56

If the dividend growth rate is 9% (consider)

𝐷 12.56
PVES = 𝑑−𝑔 = .13−.09
= 314

Convert it into todays value by multiplying the PV factor @13% of 6th year

314 x 0.480 = 150 (we have taken under 7% growth rate)

Step 3:

Present value of equity = Present value at 7% + present at 14%

= 150 +32.51

= 182.51

1. A company is expected to pay a dividend of Rs.10 per share after a year. Its
dividends are expected to grow at 12% for next four years and then at the
rate 8% for ever. Find out the present value of its share, if the capitalization
rate is 13%.