Assignment#01 Marks: 20

Financial Management

Topic: Valuation of Securities

While investing in the stock market, investors must consider certain factors before choosing
among various investment options. Some of these factors can be controlled through diversification
while market factors are inherent to every investment. A rational investor takes into account both
factors and tries to form a combination of investment options which maximizes his return at a
minimum level of risk. Apart from these factors, investors’ appetite for risk also matters a lot in
the selection process. Risk taker investors prefer high risk which results in high return while a risk-
averse investor prefers to minimize the risk at the cost of low returns. Stock market securities
provides investment options with different risks for both the risk takers and risk-averse investors.
Aneela is a young investor, and she is eager to invest in stock market for which she is looking
suitable investment options. Her fund manager has provided following two investment options
for initial investment:

Option 1. Shares of M&J Textiles issued at the face value of Rs. 100 per share with a dividend of
Rs. 10 per share for the current year which will grow at 6% for the next 3 years while dividend
growth rate will increase to 8% for an infinite time. The market is offering a 15% interest rate for
this type of investment. Currently the shares of M&J Textiles are selling at Rs. 98 per share.

Option 2. 10-years Bonds of Dhani Textiles issued at the face value of Rs. 1000 with a 12% annual
coupon. The market is offering a 15% interest rate for this type of investment. Currently the bonds
of Dhani Textiles are selling at Rs. 980.

Required:
1. Calculate intrinsic value of both investment options and identify whether these securities
are undervalued or over-valued. (11+6)
2. 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? (1+2)

NOTE: Show complete working and formula, marks will be deducted in case on
incomplete working and missing formulas.
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