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# Valuation Of Securities

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### Valuation Of Securities

1. 1. Valuation of Securities – Part ONE By, L M LEARNING Kaushal Mandalia S Made Simple
2. 2. Time Value of Money L M LEARNING S Made Simple
3. 3. Simple Interest V/s Compound Interest • Simple Interest • Compound Interest : Interest on Interest. • Example • Fixed Deposit : Rs 5,00,000 • Tenure : 3 Years • Interest Rate : 10% • Find Maturity Value in case of Simple and Compound Interest L M LEARNING S Made Simple
4. 4. Four Important Calculation • Future Value of Single Amount • Present Value of Single Amount • Future Value of Annuity • Present Value of Annuity L M LEARNING S Made Simple
5. 5. Future Value of Single Amount • How much something is worth in future…. • Example • Mr Shah has invested Rs 10 Lac in Fixed Maturity Plan for 2 years which gives guaranteed return of 12% compounded annually. What is the maturity value of Mr Shah’s Investment? L M LEARNING Ans : Rs 12,54,400 S Made Simple
6. 6. Excel Sheet Calculation L M LEARNING S Made Simple
7. 7. Present Value of Future Sum • Present Value is a synoname for Valuation Example Mr Sharma wants Rs 1 Crore Example when he turns 55 years. He Mr Ambani invested in a bond wishes to invest in Reliance whose Valuation After one Industries Share which is going year is Rs 15000. The interest to give 25% compounding rate on the bond is 10%. Find annualized return. Mr Sharma’s out the amount Mr Ambani current age is 51 years. Find out has invested today. the amount that Mr sharma Ans : 13,636 need to Invest Today. L Ans : 40,96,000 M LEARNING S Made Simple
8. 8. Future Value of Annuity Rs 10,000 Rs 10,000 Rs 10,000 Rs 10,000 Rs 10,000 Rs 10,000 Rs 10,000 Rs 10,000 Annuity Future Value Of Future value of Series of Equal Payment at definite interval. Annuity L M LEARNING S Made Simple
9. 9. Future Value of Annuity Example Mr. Lakhani wishes to Invest 10 Lacs every year for next two years at the end of each year. He is expecting 15% interest (compounded annualized). What is the future value of this investment? Ans : 21,50,000 Example Mr. Nair is a government servant and expected to get retired at the age of 58. His contribution to Provident Fund (PF) Account every year at the end of year is Rs 70000. He is getting 9% Compounded annualized return on his PF Account. What is the Future Value (Maturity Value) of this account when Mr. Nair is retired. Currently Mr. Nair is 42 Years old. Ans : 23,10,238 L M LEARNING S Made Simple
10. 10. Future Value of Annuity Nper It is the total no of payment periods in the investment Pmt It is the payment made each period. It cant change over the life of investment PV : Assume as ZERO Type 1 : Payment at the beginning of period 0 : payment at the end of the period. L M LEARNING S Made Simple
11. 11. Future Value of growing Annuity Example Find the Future value of Rs 1 lac which is growing at a rate of 5% every year. The expected interest rate is 10% and tenure of investment is 8 years. L M LEARNING S Made Simple
12. 12. Present Value of Annuity • It is used in the valuation of Bond, Securities and Preference Shares. Example Find Present Value of Annuity where Mr Sharma is investing 1 lac every year for next 8 years at the end of year. Assumed Interest rate is 10% compounded annually. Ans : 533492 L M LEARNING S Made Simple
13. 13. PV : Excel Calculation L M LEARNING S Made Simple
14. 14. PV : examples Example Face Value of 10% Annual, 2 year bond is Rs 100. Find the valuation of Bond if discount rate is 6%. At the end of 2 years, bond will be redeemed at face value. Ans : 107.33 Example Mr Sharma is investing in share of Wipro Ltd. Current Market Price of Wipro is Rs 500, Face value is Rs 10. Analyst has estimated that wipro will give 250% dividend every year and share price at the end of 8 years will be Rs 650. Should Mr Sharma invest in Wipro for 8 years? Assume discounting rate as 7% Ans : Yes, 527.59 L M LEARNING S Made Simple
15. 15. PV : examples 1. As a General Manager, Gujarat Venture Finance Ltd (GVFL), you have received a project from Suzlon Pvt Ltd to open a wind farm at Rajasthan. They wish to have 10 windmills. Each windmill is costing about 5 Crore. Each windmill generates electricity worth Rs 10 Lacs every month. The life of each Windmill is 8 years. The scrap value of each Windmill is Rs 50 Lacs. Suzlon Pvt Ltd requested GVFL to become his investment partner and invest Rs 50 crore. As a general manager of GVFL what should be your decision assuming 7% as discount rate? 2. Mr Suri is planning to buy a dream home. The cost of the home is Rs 30 Lacs. Before applying to loan Mr Suri has analyzed his cash flow and found that he is comfortable paying rs 25000 as EMI for next 15 years. The interest rate on the loan is 9%. Find out how much loan amount Mr Suri can afford? L M LEARNING S Made Simple
16. 16. Bond Valuation. L M LEARNING S Made Simple
17. 17. Terminology Par Value The Value Stated on the face of Bond is called as Face Value. Coupon Rate Bond carries a specific interest rate which is called the coupon rate. Maturity Period The maturity of a bond indicates the length of time until the bond issuer returns the par value to the bond holder and terminates or redeems the bond. Current Yield The current yield on a bond refers to the ratio of the annual interest payment to the current market price . Yield to Maturity This is the rate of return that investors earn if they buy the bond at a specific price and hold it until maturity. L M LEARNING S Made Simple
18. 18. Type of Risk Associated with Bond Interest Rate Risk The interest rate in market changes over time, and an increase in interest rate leads to a decline in the value of outstanding bonds. This risk of a decline in bond values due to rising interest rate is called Interest Rate Risk. Reinvestment Rate Risk As Interest rate in market changes over time, any decrease in interest rate may cause a company to exercise its call option for the bonds issued with call option. The bond holders will have to replace his high income bonds with low income bonds. This risk of fall in income due to fall in market interest is called as Reinvestment Rate Risk. Default Risk This risk occur when issuer of bonds default either in payment of Interest or Principal amount. L M LEARNING S Made Simple
19. 19. Accrued Interest Accrued interest is that part of the interest which is yet to be paid to bondholders, but has been earned since the last payment date C1 C2 C3 C4 C Dj C = Coupon Payment Accrued Interest = m = No of coupon payment in a year m Td Dj = No of days since last coupon payment Td = Total no of days between two coupon payment
20. 20. Examples Essar Oil pays 12 percent per annum quarterly interest rate due every March, June, Sept and Dec end. The quoted price in the market is Rs 86 on Jan 24, 2003. Determine the accrued interest as on this date? Ans : 0.74 Hotel Lee’s 10% per annum half yearly interest rates are due every March and SEpt end and has a current quoted price of Rs 44 on Feb 3. What should be the price at which the debenture will be exchanged in the market on this date? Ans : 3.46 L M LEARNING S Made Simple
21. 21. Yield to Maturity C = coupon payment F = face value of bond YTM = C + F-P P = clean price n = No of years to maturity P nXP Example 1. Kanika buys 5 year, 7% bond at Rs 99.48. What is the simple yield to maturity? Face value of bond is Rs 100. Ans: 7.15% 2. What is simple yield to maturity for 10 year, 9% bond bought at Rs 108.32? Face value Rs 100. Ans : 7.54% 3. Find YTm for 15 year, 12% bond which is bought at Rs 112.45 with 5 years maturity. Ans : 8.46% 4. Deepa buys 10 year, 8% bond with six months to maturity at Rs 99.89. Find YTm. Ans : 8.23%
22. 22. Examples 1. A rs 100 par value bond bearing a coupon rate of 12% will mature after 5 years. What is the value of bond, if discount rate is 15%? 2. The market price of Rs 1000 par value bond carrying coupon rate of 14% and maturing after 5 years is Rs 1050. What is YTM? 3. A Rs 100 par value bond bears a coupon rate of 14% and matures after 5 years. Interest is payable semi annually. Compute the value of bond if the required rate of return is 16%? Ans L 1) 89.92 M LEARNING 2) 12.6% S Made Simple 3) 93.27
23. 23. Stock Valuation. L M LEARNING S Made Simple
24. 24. Share Valuation 1. Earning Valuation • Price Earning Ratio 2. Revenue Valuation • Price to Sales Ratio = MCAp / One yr total revenue 3. Cash Flow Valuation • EBDIT • Free Cash Flow = Operational cash Flow – Capital Exp 4. Asset Valuation • Book Value • Price to Book Value • Return on Equity L M LEARNING S Made Simple
25. 25. Valuation of Equity Share Equity share valuation is comparatively a difficult task because of following reasons – 1. Rate of dividend is not known and certain. Dividend payment is discretionary. Therefore the forecast of cash flows is not certain and difficult to make. 2. Earnings & Dividends on equity shares are expected to grow. Valuation Models for Equity Share Valuation Dividend Discount Model Under this model ,the price paid for shares today will be the present value of dividend stream receivable in Future and any amount which will be realized after sale of shares. L M LEARNING S Made Simple
26. 26. Single Period Valuation Model ASSUMPTIONS • Dividends are paid annually. • The first dividend will be received one year after the equity share is purchased. • The share is held only for one year. D1 P1 P0 = Current Price of Equity Share P0 = + D1 = Dividend expected a year hence (1+r) (1+r) P1 = Price of the share expected a year hence R = rate of return required on equity share L M LEARNING S Made Simple
27. 27. Example • Prestige’s equity share is expected to provide a dividend of Rs 2.00 and fetch a price of Rs 18.00 a year hence. What price would it sell for now if the investor’s required rate of return is 12% Ans : Rs 17.86 L M LEARNING S Made Simple
28. 28. Constant Growth Model • What happens if the price of the equity share and dividend is expected to grow at a rate of g percent annually? The formula is….. • Example – The expected dividend per share of XYZ Ltd is Rs 2.00. The dividend per share has grown over the past five years at D1 the rate of 5% pa. This growth will continue in future. The market P0 = price of the equity share is also expected to grow at the same r-g rate. What is a fair estimate of the intrinsic value of the equity share if the required rate of return is 15% Ans : Rs 20.00 L M LEARNING S Made Simple
29. 29. Expected Rate of Return D1 r = P0 + g • Example – The expected dividend per share of Vaibhav Ltd is Rs 5.00. The dividend is expected to grow at the rate of 6%pa. If the price per share now is Rs 50.00, what is the expected rate of return? Ans : 16% L M LEARNING S Made Simple
30. 30. Multi Period Valuation Model With no fixed ,pre determined maturity period dividend stream may be of infinite duration. In this case P0 will be computed differently. n D1 Pn P0 = + (1+r) t (1+r) n t=1 L M LEARNING S Made Simple
31. 31. Zero Growth Model Dividend Remains same throught the period perpatually.. D P0 = r L M LEARNING S Made Simple
32. 32. Multi Period Growth Model • Normally applicable to relatively young and fast growing firms who do not pay steady dividend. The dividend profile looks like below..
33. 33. Example • Lets imagine that a high tech firm’s earnings are growing @ 50% a year, which is not uncommon for such companies, if this rate is assumed to last forever, what should be the fair valuation of stock if the discount rate is 25% and Dividend at the end of year 1 is Rs 10 per share. D1 P0 = r-g Negative price is not realistic…… hence some correction is needed. L M LEARNING S Made Simple
34. 34. Limitation of earlier models • No firm can sustain high growth rate until infinity since competition will soon jump in and erode sales growth and profitability. • Little or no dividend in early years. • In order to handle this situation, researchers relaxed the constant growth assumption and came up with multi period growth model for stock valuation L M LEARNING S Made Simple
35. 35. Multi Period Valuation Model • Since no firm can grow at an extraordinarily high rate forever, the model splits the life of firm into two phases 1. The early Years, 2. The maturity or steady state years. L M LEARNING S Made Simple
36. 36. Multi Period Valuation Model
37. 37. Multi Period Valuation Model L M LEARNING S Made Simple
38. 38. Example • Pepsico Beverage has just introduced a new flavor in the market. Pepsico’s earning and dividend is expected to grow at 30% pa during next four years, after which they are expected to stabilize at 6% a year. The most recent dividend paid was Rs 3 per share. Analysts have estimated that given the risk of the stock, a discount rate of 14% is appropriate for discounting Pepsico’s future dividends. What is the fair value of stock? L M LEARNING S Made Simple
39. 39. L M LEARNING S Made Simple
40. 40. Example • XYZ Ltd, has just been listed on NYSE. They went public this year only. XYZ is not expected to pay any dividend for next three years. It is expected to pay Rs 0.50 in forth year and 0.75 in fifth year. Beginning sixth year, its dividend will grow at a constant 5% annually. Given a discount rate of 18% what is the fair value of stock today? Ans : Rs 3.24 L M LEARNING S Made Simple
41. 41. LearningMadeSimpleTM Learning Made Simple is initiative taken by few people earlier related to the Corporate World whose aim is to provide quality education and training to those who wish to excel in their career path. Learning Made Simple is an association who works on a no profit no loss basis and provide training and development in the era of Financial Planning, Financial Management, AMFI, NCFM, Management Concepts, Soft Skills, Leadership, Personality Development, Goal Setting, Marketing Management, Behavioral Science, NLP and various other segments. You can get in touch with us by sending email on kaushal@thefinancialplanners.in