Good Valuation = story + numbers

While numbers provide objectivity, story connects us with emotions

Without numbers story becomes a fairy tale leading to unreal valuation
While only numbers can be manipulated & used to hide bias

For example last week in Shark Tank, a group of businessmen from Kerla made a product
from Coconut water and made a very good profits just in 3 years
After digging out the matter it was revealed that NP margin is 80% because these people sold 3 franchiseee
and not the products….. So how long you will be able to sell franchisee?

Valuation is not a Science, nor an Art but it is craft

Craft is a skill you develop while doing it

Need of a proper assessment of an enterprise’s value can be typically for

a Information for its internal stakeholders

b Comparison with similar enterprises for understanding management efficiency
c Future public listing of the enterprise
d Strategic planning, for e.g. finding out the value driver of the enterprise, or for a correct
deployment of surplus cash
e Ball park price (i.e. an approximate price) for acquisition

For transfer of shares of unlisted companies…..arrive at a fair value

Legal Required under companies Act for further issue of shares
Reasons Under FEMA …..when FDI / ODI occurs
Under Income Tax Act for issue as well as transfer of securities

Core principles of valuation always remain the same

We can make reasonable estimates of value for most assets, and that the fundamental principles
determining the values of all types of assets whether real or financial, are the same

Few concepts:
1 Required rate of Return
2 Discount rate
3 IRR Today am investing Rs 100
4 Equity Risk Premium After 3 years I expect Rs 150 from this investment
5 Required return on equity What is my IRR?
6 Selection of Discount rate 1.144714 0.144714

Valuation of Equity shares

Dividend based model
Earnings based models
Cash flow based models
 Valuation of securities
1 Valuation of preference shares
Convertible & Non Convertible

2 Valuation of Bonds & debentures

3 Valuation of Equity shares

ple sold 3 franchiseee

TCS ….last 4 years continuously buying its own shares

Parent company? Tata Sons Ltd
Tata Sons is having a stake of 72%
TATA Sons is geeting high cash flow from TCS
Dividend
Buy-back of shares

TCS is holding some 52K crores

If company is sitting on cash

1. It for re-investment in business …...JSW Steel
2. No such requirement internally , then look beyond that
amental principles are there opportunities of Diversification? OR Acquisitions

Book Value of shares goes up

You have to give returns on this enhanced base
that increases your cost of capital

TWO TYPES OF COMPANIES

1 CASH RICH COMPANY …. Mostly software companies

2 CAPITAL INTENSIVE COMPANIES …... Manufacturing companies

Another classification
1 Asset heavy
2 Asset Light

Third classification
1 All equity company i.e debt free company
2 Leveraged company …..hevy debts

in 2019 L & T wanted to go for buy-back for

9000 crores

SEBI didn't allow this….

Cash Burning companies

 Valuation Based holding period of One Year
Share of X Ltd. is expected to be sold at Rs. 36 with a dividend of Rs. 6 after one
year. If required rate of return is 20% then what will be the share price?

Valuation Based on Multi Holding Period

i Zero Growth
ii Constant growth
iii Variable growth in dividend

17-Jan-22

1 A company has a book value per share of Rs. 137.80. Its return on equity is 15%
and it follows a policy of retaining 60% of its earnings. If the Opportunity Cost of Capital
is 18%, compute the price of the share today using both Dividend Growth Model
and Walter’s model

2 ABC Limited’s shares are currently selling at Rs. 13 per share. There are
10,00,000 shares outstanding. The firm is planning to raise Rs. 20 lakhs to Finance
a new project
What are the ex-right price of shares and the value of a right, if
The firm offers one right share for every two shares held
The firm offers one right share for every four shares held

3 MNP Ltd. has declared and paid annual dividend of Rs. 4 per share.
It is expected to grow @ 20% for the next two years and 10% thereafter.
The required rate of return of equity investors is 15%.
 Compute the current price at which equity shares should sell

4 On the basis of the following information

Current dividend (Do) Rs. 2.50
Discount rate (k) 10.50%
Growth rate (g) 2%

a Calculate the present value of stock of ABC Ltd

b Is its stock overvalued if stock price is Rs. 35, ROE = 9% and EPS = Rs. 2.25?
c Show detailed calculation. Using PE Multiple Approach and Earning Growth Model

5 X Limited, just declared a dividend of Rs. 14.00 per share. Mr. B is planning to purchase the
share of X Limited, anticipating increase in growth rate from 8% to 9%, which will continue
for three years. He also expects the market price of this share to be Rs. 360.00 after three
years. You are required to determine
i the maximum amount Mr. B should pay for shares, if he requires a rate of return of 13% per annum
ii the maximum price Mr. B will be willing to pay for share, if he is of the opinion that
the 9% growth can be maintained indefinitely and require 13% rate of return p.a.
iii the price of share at the end of three years, if 9% growth rate is achieved and
assuming other conditions remaining same as in (ii) above

Ans ii 381.5

Ans iii 19.76214254

494.0535635 Expected market price at the end of 3 years

6 A company pays a dividend of Re. 1.00 per share and has a share price of Rs. 20
If this dividend were expected to grow at a rate of 12% per annum forever, what is
the firm’s expected or required return on equity using a dividend-discount model
approach?
Instead of this situation in part (i), suppose that the dividends were expected to grow
 at a rate of 20% per annum for 5 years and 10% per year thereafter. Now what is the
firm’s expected, or required, return on equity?

7 Capital structure of Sun Ltd., as at 31.3.2003 was as under

(Rs. in
lakhs)
Equity share capital 80
8% Preference share
40
capital
12% Debentures 64
Reserves 32
Sun Ltd., earns a profit of Rs. 32 lakhs annually on an average before deduction of
income- tax, which works out to 35%, and interest on debentures
Normal return on equity shares of companies similarly placed is 9.6% provided
Profit after tax covers fixed interest and fixed dividends at least 3 times
Capital gearing ratio is 0.75
Yield on share is calculated at 50% of profits distributed and at 5% on undistributed
profits
Sun Ltd., has been regularly paying equity dividend of 8%
Compute the value per equity share of the company assuming
1% Risk premium for every one time of difference for Interest and Fixed Dividend Coverage
2% Risk premium for every one time of difference for Capital Gearing Ratio

A company is maintaining g=10% in dividends. Company has paid dividend of Rs 3/share

Market return is 12%, Rf is 8% & Beta is 1.5
Calculate the expected rate rate of return on company's shares as per CAPM model
& equilibrium price per share by dividend growth model
 Earnings Based Models Cash Flow based Models

1 Gordon's Model FCFF

Walter's approach FCFE
P/E

Solution 1
BV = 137.80 BV is Net assets / Total number of equity shares
Net assets = Total assets - Liabilities

RoE = 15% of BV 20.67 Earnings

60% is retained i.e 40% is distributed as dividend
Dividend is 8.268
g = growth rate of the firm
g = RoE *Retention ratio
0.09
Ke =18% 91.87 Value as per dividend growth model

Vc= D + (Ra/Rc)*(E-D) /Rc

Ra = Internal Return on equity = 15%
Rc = Cost of Capital

18.605
103.3611 Value per share as per Walter's Formula

CMP = Rs.13 at present 10 Lakh shares

If plan is raise Rs 20 Lakhs

Rights offer is 1:2 Therefore, 4

EX-Right price of a share

(i) 15,000,000 Value of all shares after Rights issue
1,500,000 Total number of shares after Rights issue
10 Ex-right price of a share

(ii) 15,000,000
1,250,000
12

Last declared dividend is Rs. 4

D1 4.8
D2 5.76
D3 6.336 TV= (6.336)/ (15%-10%)
126.72
Based on D3, we have to compute Terminal Value
To obtain current price, discount all the above at 15%

4.173913 4.355387523629 95.81852552

i.e. 104.3478

a. 2.55 D1
D1/ Ke-g 30

b PE Multiple = 1/RoE
RoE=9% EPS = 2.25
PE Multiple 11.111111111
EPS * PE = Market price
25 Estimated market price
Actual market price is Rs. 35 therefore this is
overvalued

C Value based on earnings growth model

EPS is 2.25, g=2%
(EPS*1+g)/Ke-g

27

Required rate of return is 13%

g=9%
D0 = 14
Market price per share after 3 years will be 360
Calculate current estimated price you will pay

Discount all future 3 year's cash flows PV

Y1 15.26 0.884955752212 13.504424779
Y2 16.6334 0.783146683374 13.026392043
Y3 18.13041 0.693050162278 12.56528082
Y3 360 0.693050162278 249.49805842
288.59415606
This is the max price one will pay today.

Find out Ke here based on DDM

Ke = (D1/P0)+g D1=1.12 0.176

P0=20
g=12%
Hint for second question = Market price is 20
20 = Discounted dividends for next 5 years + TV at
some trial rate of say 18% and find out if it matches Rs 20
Then try another rate of say 19% and work it out again
Like IRR, compute the exact rate of discount which is your Ke