The document outlines various methods for equity valuation, including fundamental analysis, discounted cash flow models, and relative valuation techniques like price-earnings and price-to-book ratios. It emphasizes the importance of intrinsic value in investment decisions and provides detailed steps for calculating value per share using methods like the dividend discount model and free cash flow model. Additionally, it covers practical examples to illustrate intrinsic value calculations and key financial ratios used for valuation comparisons.

1. Equity Valuation

2. Learning outcome
• To learn how to calculate value of a equity share by using
different valuation models.
• To learn about the role of Intrinsic value in the investment
decision.

3. Introduction
• Equity shares can be described more easily than fixed income
securities, however they are more difficult to analyse.
• Fixed income having a limited life and a well defined cash
flow stream, equity share have neither.
• Fundamental analysis assess the fair market value of equity
shares by examining the assets, earning prospects, cash flow
projections and dividend potential.

4. Fundamental valuation
• Balance sheet valuation
– Book value
– Liquidation value
– Replacement value
• Discounted cash flow models
– Dividend discount model
• Single period valuation, Multiple period valuation.
– Free cash flow model
• Relative valuation techniques
– Price-earning ratio
– Price book value ratio

5. Balance sheet valuation
• Book value:- Book value per share is simply the net worth of
the company(which is equal to paid up equity capital plus
reserves and surplus) divided by no. of shares outstanding.
• Liquidation value:- Value realised from liquidating all the
assets of the firm – amount to be paid to all the creditors and
preference shareholders divided by no. of outstanding equity
shares.
• Replacement cost:- this measure considered by analysts in
valuing firm is the replacement cost of its assets less liabilities
divided by no. of outstanding equity shares.

6. Dividend discount model
• The value of an equity share is equal to the present value of
dividends expected from its ownership plus the present value
of the sale price expected when the equity share is sold.
• Assumptions
1. Dividends are paid annually.
2. The first dividend is received one year after the equity share
is bought.

7. DIVIDEND DISCOUNT MODEL
•SINGLE PERIOD VALUATION MODEL
D1 P1
P0 = +
(1+r) (1+r)
•A equity share is expected to provide a dividend of Rs 2 and fetch a price
of Rs 18 a year hence. What price would it sell for now if investor’s
required rate of return is 12%.

8. SINGLE+ GROWTH
• What happens if the dividend of the equity
share is expected to grow at a rate of g
percent annually.
D1
P0 = r – g
• The expected dividend per share on the equity share of a
company is Rs 2. the dividend per share has grown over the
past five years @ 5%. This growth will continue in future.
What is the fair value of the equity share if the required rate
is 15%.

9. DIVIDEND DISCOUNT MODEL
•MULTI - PERIOD VALUATION MODEL
 Dt
P0 = 
t=1 (1+r)t

10. DIVIDEND DISCOUNT MODEL
•ZERO GROWTH MODEL
If the dividend per year remain constant.
D
P0 =
r
•CONSTANT GROWTH MODEL
assumes that dividend per year grows at a constant rate g.
D1
P0 =
r - g

11. Free Cash Flow Model
• It involves determining the value of the firm as a whole(the
value is called enterprise value) by discounting the free cash
flow to investors and then subtracting the value of preference
and debt to obtain the value of equity.
• It involves following steps.

12. Steps 1
1. Divide the future into two parts, the explicit forecast period
and the balance period.
Explicit period- represents the period during which the
firm is expected to evolve and finally reach a steady state.
Balance period- a state in which the return on invested
capital, growth rate and cost of capital stabilise.

13. Step 2
• Forecast the free cash flow, year by year, during the explicit
forecast period.
FCF is the cash flow available for distribution to capital
providers(Shareholders and debt holders) after providing for
the investment in fixed assets and net working capital
required to support the growth of the firm.
FCF= NOPAT- Net Investment
NOPAT is net operating profit after taxes. It is profit before
interest and taxes(1- Tax rate).
Net Investment: Change in net fixed assets + Change in net
working capital.

14. Step 3
• Calculate the weighted average cost of capital
WACC= WeRe + WpRp + WdRd (1-t)

15. Step 4
• Establish the horizon value of the firm
Horizon value is the value placed on the firm at the end of the
explicit forecast period(H years) Since the FCF is expected to
grow at a constant rate of g beyond h, horizon value is equal
to
VH
= FCF H+1
wacc-g

16. Step 5
• Estimate the enterprise value
The EV or value of the firm is the present value of the FCF
during the explicit forecast period plus the present value of
the horizon value.

17. • Step 6: Derive the equity value=
Enterprise value – Preference value- Debt value
• Step 7: Compute the value per share
The value per share is simply the equity value divided by the
no of outstanding equity shares.

18. Example
• The balance sheet of Cosmos Limited at the end of year 0 (the
present point of time) is as follows.
Rs. in crore
Liabilities Assets
 Shareholders’ funds 500  Net fixed assets 550
 Equity capital 200
(20 crore shares of
Rs. 10 each)
 Net working capital 200
 Reserves and surplus 300
 Loan funds( rate
10 percent) 250
750 750

19. Additional information
• The return on assets( NOPAT) is expected to be 18 percent of
the asset value at the beginning of each year. The growth
rate in assets and revenues will be 30 percent for the first
three years, 18 percent for the next two years, and 10
percent thereafter. The effective tax rate of the firm is 34
percent, the pre-tax cost of debt is 10 percent and the cost of
equity is 24 percent. The debt-equity ratio of the firm will be
maintained at 1:2. Calculate the intrinsic value of the equity
share.

20. Solution Step 1 and 2
Rs. In crore
Year 1 2 3 4 5 6
Asset value (Beginning) 750.0 975.0 1267.50 1647.75 1944.35 2294.33
NOPAT 135.0 175.50 228.15 296.60 349.98 412.98
Net investment 225.00 292.50 380.25 296.60 349.98 229.43
FCF (90.0) (117.0) (152.1) - - 183.55
Growth rate (%) 30 30 30 20 20 10

21. Solution
3. The weighted average cost of capital is:
WACC = (2/3) x 24 + (1/3) x 10 (1-0.34) = 18.2
percent
4. The horizon value of the firm =
(183.55 x 1.10)
(0.182-0.10) = 2462.26 crores

22. Solution
• Step 5. The enterprise value is:
• Step 6: The equity value is
EV =
-90.00
-
117
-
152.1
+
0
(1.182) (1.182)2
(1.182)3 (1.182)4
+
0
+
183.55
+
2462.26
(1.182)5
(1.182)6
(1.182)6
Enterprise
value
- Debt value = 718.19 – 250.0 = Rs. 468.19Crores

23. Solution
• The value per share is:
Rs. 468.19 Crore / 20 crore = Rs. 23.41

25. Price-Earnings Ratio - P/E Ratio
A valuation ratio of a company's current share price compared
to its per-share earnings. Calculated as:
Market Value per Share/ Earnings per Share (EPS)
For example, if a company is currently trading at 43 a share and
earnings over the last 12 months were 1.95 per share, the P/E
ratio for the stock would be 22.05 (43/1.95).

26. Earning Multiplier Approach
• The P/E is sometimes referred to as the "multiple", because it
shows how much investors are willing to pay per rupee of
earnings. If a company were currently trading at a multiple
(P/E) of 20, the interpretation is that an investor is willing to
pay 20 for 1 of current earnings.

27. Analysis
• A high P/E suggests that investors are expecting higher
earnings growth in the future compared to companies with a
lower P/E.
• Compare the P/E ratios of one company to other companies
in the same industry, to the market in general or against the
company's own historical P/E.

28. Price to book value ratio
• A ratio used to compare a stock's market value to its book
value. It is calculated by dividing the current closing price of
the stock by the latest quarter's book value per share.
• A lower P/B ratio could mean that the stock is undervalued.
• As with most ratios, be aware that this varies by industry.

29. Price-to-Earnings (P/E) Ratio: This ratio compares a company's stock
price to its earnings per share (EPS). It is calculated by dividing the
market price per share by the EPS. A higher P/E ratio indicates that
investors are willing to pay more for the company's earnings.
Price-to-Sales (P/S) Ratio: This ratio compares a company's stock price
to its revenue per share. It is calculated by dividing the market price
per share by the revenue per share. A higher P/S ratio indicates that
investors are willing to pay more for the company's sales.
Enterprise Value-to-EBITDA (EV/EBITDA) Ratio: This ratio compares a
company's enterprise value to its earnings before interest, taxes,
depreciation, and amortization (EBITDA). . It is commonly used in
valuation of companies with high levels of debt. A lower EV/EBITDA
ratio indicates that the company is undervalued.
Price-to-Book (P/B) Ratio: This ratio compares a company's stock price
to its book value per share (total assets minus intangible assets and
liabilities divided by the number of outstanding shares). A higher P/B
ratio indicates that investors are willing to pay more than the
company's book value.

30. DPS

33. Retention ratio is the opposite of dividend payout ratio and
measures the percentage of net income not paid to the
shareholders in the form of dividends. It is nothing but (1-DPR).
• Example: The following is the figure for Asha International
during the year2008-09:
• Net Income: Rs. 1,000,000
• Number of equity shares (2008): 150,000
• Number of equity shares (2009): 250,000
• Dividend paid: Rs. 400,000
• Calculate the earnings per share (EPS), dividend per share
(DPS), dividend payout ratio and Retention ratio for Asha
International

35. Calculate P/E
• Example: Stock XYZ, whose earning per share
is Rs. 50 is trading in the market at Rs. 2000.
What is the price to earnings ratio for XYZ?

38. THE DUPONT MODEL

44. • Example: ABC Company paid a dividend of Rs.
5 per share in 2009 and the market price of
ABC share at the end of 2009 was Rs. 25.
Calculate the dividend yield for ABC stock