valuation of securities in modern world.pptx

Strategic Management

1. V ALU A TION OF SECURITIES

2. V ALU A TION

3. Securities/Assets could be valued on the basis of following Book Value: It is an accounting concept. It is the difference between book value of total asset and book value of total External liability. Also known as net worth/Shareholders fund. Market Value: The current price at which the security can be sold is market price. Going Concern Value: The amount a business concern could realize if the business is sold as an operating unit is known as going concern value. Going Concern Value depends upon the ability to generate sales and profits in the future. Liquidating Value: The amount which the owners would realize after having liquidated the business it firms liquidation value. It may also be zero. Replacement Value: It is the amount which is required to replace the existing assets.

4. 6. Capitalized Value : The Capitalized value of a financial asset is the sum of present value of cash flows from an asset. It is also known as Economic Value.

5. VALUATION OF BOND/DEBENTURES P.V. = + 𝐶 𝑇𝑉 (1+𝑟) 𝑡 (1+𝑟) 𝑛 P.V. = Present Value C = Coupon or interest for the time ‘t’ T.V. = Terminal Value repayable at maturity (at par, premium or discount) r = Internal rate of return or cost of capital n = number of years to maturity

6. An investor purchases a bond whose face value is 1000, maturity period is 5 years and coupon rate is 7%. The required rate of return is 8%. What amount he should be willing to pay now to purchase the bond if it matures at par.

7. An investor purchases a bond whose face value is 1000, maturity period is 5 years and coupon rate is 7%. The required rate of return is 8%. What amount he should be willing to pay now to purchase the bond if it matures at par. Solution P.V. = (𝟏+𝒓) 𝟏 (𝟏+𝒓) 𝟐 (𝟏+𝒓) 𝟑 (𝟏+𝒓) 𝟒 + + + + + 𝑪𝟏 𝑪𝟐 𝑪𝟑 𝑪𝟒 𝑪𝟓 𝑻𝑽 (𝟏+𝒓) 𝟓 (𝟏+𝒓) 𝟓 P.V. = 𝟕𝟎 𝟕𝟎 𝟕𝟎 𝟕𝟎 + + + + 𝟕𝟎 + (𝟏+.𝟎𝟖) 𝟏 (𝟏+.𝟎𝟖) 𝟐 (𝟏+.𝟎𝟖) 𝟑 (𝟏+.𝟎𝟖) 𝟒 (𝟏+.𝟎𝟖) 𝟓 (𝟏+.𝟎𝟖) 𝟓 𝟏𝟎𝟎𝟎 P.V. P.V. = 64.81 + 60.01 + 55.57 + 51.45 + 47. 64 + 680.58 = 960.06

8. If half yearly calculation is to be done Number of years must be multiplied with 2 Coupon payment must be divided by 2 Coupon rate must be divided by two Coupon = 70/2 =35 r = 0.8/2 = 0.4 N = 10 years = + 𝟑𝟓 𝟑𝟓 + 𝟑𝟓 (𝟏+.𝟎𝟒) 𝟑 + 𝟑𝟓 + + + + 𝟑𝟓 𝟑𝟓 𝟑𝟓 𝟑𝟓 (𝟏+.𝟎𝟒) 𝟒 (𝟏+.𝟎𝟒) 𝟓 (𝟏+.𝟎𝟒) 𝟔 (𝟏+.𝟎𝟒) 𝟕 (𝟏+.𝟎𝟒) 𝟖 + (𝟏+.𝟎.𝟒) 𝟏 (𝟏+.𝟎.𝟒) 𝟐 𝟑𝟓 𝟑𝟓 (𝟏+.𝟎𝟒) 𝟗 (𝟏+.𝟎𝟒) 𝟏𝟎 + + 𝟏𝟎𝟎𝟎 (𝟏+.𝟎𝟒) 𝟏𝟎

9. V ALU A TION OF ZERO COUPON BOND The debt instrument which do not pay any interest. But issue at discount and redeemed at par. So the present value of redemption amount/terminal amount will be the value of zero coupon bond. 𝑇𝑉 P.V. = (1+𝑟) 𝑛

10. YIELD TO MATURITY The yield to maturity, book yield or redemption yield is rate of return earned by an investor who purchases bonds and holds it till maturity. Yield to maturity is the discount rate at which the sum of all future cash flows from the bond (coupons and principal) is equal to the current price of the bond. Same as internal rate of return.

11. Valuation of Preference 1. Value of Redeemable preference share is determined same as Bonds. P.V. = 𝑷𝒅𝟏 (𝟏+𝒓) 𝟏 + 𝑷𝒅𝟐 (𝟏+𝒓) 𝟐 + 𝑷𝒅𝟑 (𝟏+𝒓) 𝟑 + 𝑷𝒅𝟒 (𝟏+𝒓) 𝟒 + 𝑷𝒅𝟓 (𝟏+𝒓) 𝟓 + 𝑻𝑽 (𝟏+𝒓) 𝟓 2. Value of Irredeemable preference share is determined by the following formula: Po = 𝑃𝑑 𝑘𝑝

12. Sample Problem: 1. 5-year,P10,000 debenture bond, 10% p.a. interest payable annually is offered to Joy at 98. At the time the bond is offered to Joy it has 3-year remaining life and Joy require a rate of return of 12%. What is the value of the bond? Should Joy purchase the bond? 2. The P1,000 face value Megaworld Company bond has a coupon rate of 6%, with interest paid semi-annually, and matures in 5 years. If the bond is priced to yield 8%, what is the bond's value today?

13. V ALU A TION OF EQUITY

14. VALUATION OF EQUITY ON THE BASIS OF ACCOUNTING INFORMATION 1 Book Value Approach: it is simply the firms net worth divided by Number of equity shares. Net Worth = Equity share capital+ reserves and surplus- accumulated losses Net Worth = Total asset – Total External Liabilities Book Value of Equity = net worth 𝑵𝒖𝒎𝒃𝒓 𝒐𝒇 𝑬𝒒𝒖𝒊𝒕𝒚 𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔

15. 2. Liquidation Value Approach: The liquidation value of an equity share is the amount of cash that would be received from the company if all its assets are sold and all its liabilities are paid . liquidation value = 𝑉𝑎𝑙𝑢𝑒 𝑟𝑒𝑎𝑙𝑖𝑠𝑒𝑑 𝑓𝑟𝑜𝑚 𝑎𝑠𝑠𝑒𝑡𝑠−𝑎𝑚𝑜𝑢𝑛𝑡𝑠 𝑝𝑎𝑦𝑏𝑙𝑒 𝑡𝑜 𝑎𝑙𝑙 𝑐𝑟𝑒𝑑𝑖𝑡𝑜𝑟 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟

16. VALUATION OF EQUITY ON THE BASIS OF DIVIDEND 1. Single Period Valuation Model: When equity share is held by investor for just one year. (𝟏+𝒓) 𝟏 Po = 𝑫𝟏 + 𝑷𝟏 (𝟏+𝒓) 𝟏

17. Solution: Problem: Bright Limited is expected to declare a dividend of Philippine Peso 5 and reach a price of 70 Philippine peso a year. What is the price at which the equity share would be sold to the investors now if the required rate of return is 14%.

18. Multiperiod Dividend Valuation Model When an investor holds an equity shares for n number of year, the value of share is the present value of all future stream of dividends. P0 = 𝑫 𝑫 + + (𝟏+𝒓) 𝟏 (𝟏+𝒓) 𝟐 (𝟏+𝒓) 𝟑 𝑫 + 𝑫 (𝟏+𝒓) 𝟒 + 𝑫 (𝟏+𝒓) 𝟓 …………….

19. ON THE BASIS OF GROWTH OF DIVIDEND 1. Zero growth in dividend or constant dividend Po = 𝐷 𝑘𝑒 2. Constant growth in dividend Po = 𝐷 𝑘𝑒−𝑔

20. Suppose a firm pays a dividend of 20% on the equity shares of face value of rs. 100 each. the required rate of return of the investor is 15%. Find out the value of equity shares given that the dividend rate is expected to remain same and the dividend rate is expected to grow constantly at 3% Solution 𝑘𝑒 Po = 𝐷 × 100 15 Po = 20 × 100 Po = 133.33 𝐷 𝑘𝑒−𝑔 20 15−.03 Po = × 100 Po = × 100 Po = 133.60

21. VALUATION OF SHARES ON THE BASIS OF EARNINGS

22. P/E RATIO P/E Ratio = 𝑀𝑃𝑆 𝐸𝑃𝑆 EPS = 𝐸𝑎𝑟𝑛𝑖𝑛𝑔 𝑓𝑜𝑟 𝑒𝑞𝑢𝑖𝑡𝑦𝑠 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 Value of equity Share = EPS× P/E Ratio

23. CAPITAL ASSET PRICING MODEL (CAPM)

24. Capital Asset Pricing Model It was later adapted by other economists and investors, including William Sharpe, Merton miller, Jack Treynor, John Lintner. Sharpe, Markowitz and Merton Miller jointly received the 1990 Nobel Prize in Economics for this contribution to the field of financial economics CAPM describes the relationship between an investor’s risk and the expected return. It is designed to help model the pricing of higher- risk securities. In other words, we can say that it is expected rate of return on high risk securities According to the CAPM theory, the expected return of a particular security or a portfolio is equal to the rate on a risk- free security plus a risk premium. The capital asset pricing model (was developed Markowitz. in 1952 by Harry

25. ASSUMPTIONS OF CAPM The market is perfect : there are no taxes, there are no transaction costs, securities can be bought and sold freely and easily, information is available freely and easily. The investors are risk averse i.e. they try to avoid risk. Investors have homogenous expectations of returns. Investors can borrow and lend freely at the riskless rate of interest. All investors aim to maximize economic value.