Valuation of Bonds & Stocks
Valuation of Bonds & Stocks
Valuation of Bonds & Stocks
AND STOCKS
CONCEPTS OF VALUE
• Liquidation Value
• Book Value
• Market Value
• Intrinsic Value
BASIC VALUATION MODEL
The value of any asset, real or financial, is equal to the
present value of the cash flows expected from it.
C1 C2 Cn
V0 = + + ………+
(1+k) (1+k)2 (1+k)n
=
I x PVAkd,n + F x PVkd,n
Example
Rs.100 par .. 12 percent coupon
8 years maturity … Required return 14 percent
= Rs. 90.77
Pure discount bonds are called deep-
discount bonds or zero-interest bonds or
zero-coupon bonds.
The market interest rate, also called the
market yield, is used as the discount rate.
Value of a pure discount bond = PV of the
amount on maturity:
The longer the maturity of a bond, the
higher will be its sensitivity to the
interest rate changes. Similarly, the price
of a bond with low coupon rate will be
more sensitive to the interest rate
changes.
However, the bond’s price sensitivity can
be more accurately estimated by its
duration. A bond’s duration is measured
as the weighted average of times to each
cash flow (interest payment or repayment
of principal).
The value of the preference share would be
the sum of the present values of dividends
and the redemption value.
A formula similar to the valuation of bond
N o t e t h a t t h e p r e s e n t v a lu e o f R s 1 0 1 .3 0 is a c o m p o s it e o f t h e p r e s e n t v a lu e o f d iv id e n d s , R s 6 5 .0 6 a n d
t h e p r e s e n t v a lu e o f t h e r e d e m p t io n v a lu e , R s 3 6 .2 4 .T h e R s 1 0 0 p r e f e r e n c e s h a r e is w o r t h R s 1 0 1 .3 t o d a y
a t 1 0 .5 p e r c e n t r e q u ir e d r a t e o f r e t u r n . T h e in v e s t o r w o u ld b e b e t t e r o f f b y p u r c h a s in g t h e s h a r e f o r R s 1 0 0
to d a y .
The valuation of ordinary or equity shares
is relatively more difficult.
◦ The rate of dividend on equity shares is
not known; also, the payment of equity
dividend is discretionary.
◦ The earnings and dividends on equity
shares are generally expected to grow,
unlike the interest on bonds and
preference dividend.
The Dividend capitalisation model
Po = D1 + P1
(1+ke) (1+ke)
Multi Period valuation-
Constant dividend
Po = D/Ke
e.g. The value of an equity share with
constant dividend of Rs.30 per share and
equity capitalisation rate of 15 % would be
Rs.200.
Growing dividends:
Dividend expected for the year n is given by
D(1+g)n
:Rs.500L
Depreciation expenses for 17-18 :Rs.100L
Effective tax rate :30 %
The expected capital expenditure :Rs.200L
Additional working capital required Rs.50L
The FCFs are expected to grow at a constant
rate of 6 % p.a.
Cost of equity 14 % and WACC is 10 %
The market value of company’s debt is 2,000L
20 Lacs of equity stock is outstanding
The value of an asset is compared to the
values assessed by the market for similar or
comparable assets.
Since the absolute prices cannot be compared
perceptions e.g.:
the objective is to sell a security at that price
PE)
Forecasted earnings per share next year (Forward
Steps involved:
1. Estimate the earning per share
2. Establish a Price-earnings multiple
3. Develop a value range
The P/E ratio is derived as :
(1-b)
ke – (ROE x b)
Where:
(1-b) is the dividend payout ratio
Ke is the cost of equity
(ROE x b) is the expected growth rate
Riskier the stock higher is the Ke and hence
lower is the P/E multiple
The enterprise value to EBITDA multiple is
obtained by netting cash out
against debt to arrive at enterprise value and
dividing by EBITDA.
Enterprise Value =
EBITDA
(Market Value of Equity + Market Value of Debt – Cash)
EBITDA
EBITDA( EV/EB
Firm EPS L) M.P. EV P/E TDA
A 10 150 200 1800
B 8 100 120 1500
C 15 200 330 2800
AVG. 19 14
The current dividend on an equity share of Omega
Limited is Rs.8.00 on an earnings per share of Rs.
30.00. (i) Assume that the dividend per share will
grow at the rate of 20 percent per year for the next
5 years. Thereafter, the growth rate is expected to
fall and stabilise at 12 percent. Investors require a
return of 15 percent from Omega’s equity shares.
What is the intrinsic value of Omega’s equity share?
(Ans. 415.02)