Amity Business School

Valuation Concepts
FIBA601
 Amity Business School

• Concept of Valuation
• Return on Investment(ROI),
• Introduction to EVA,
• Calculating EVA
• Economic Value Added &
• Market value added
• Shareholder Value creation
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Valuation of Bonds
and Stocks
 Amity Business School

Valuation Concepts

Liquidation Book Value Market Value Intrinsic

value Value
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Intrinsic Value of Bonds

• Par Value
• Coupon rate
• Coupon (amount)= par value*Coupon rate
• Maturity period

𝑃 = 𝐶 ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,𝑛𝑦𝑟𝑠
Amity Business School
 Amity Business School

Numerical
• Compute the price of a bond , consider
10yr ,12%coupoun with par value of Rs
1000 and yield of the bond is 13%.

𝑃 = 𝐶 ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,𝑛𝑦𝑟𝑠
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• C = .12*1000= 120
• r = 13%
• M = 1000

𝑃 = 120 ∗ 𝑃𝑉𝐼𝐴𝐹13%,5 𝑦𝑟𝑠 + 1000 ∗ 𝑃𝑉𝐼𝐹13%,5𝑦𝑟𝑠

= 946.1
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• Compute the price of a bond , consider

10yr ,12%coupoun with par value of Rs
1000 and will be redeemed at 10%
premium and yield of the bond is 13%.
 Amity Business School

• C = .12*1000= 120
• r = 13%
• M = 1000*1.1= 1100

𝑃 = 120 ∗ 𝑃𝑉𝐼𝐴𝐹13%,5 𝑦𝑟𝑠 + 1100 ∗ 𝑃𝑉𝐼𝐹13%,5𝑦𝑟𝑠

= 976
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• Semi annual bond

𝐶
𝑃 = ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,2𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,2𝑛𝑦𝑟𝑠
2 2 2

• Zero Coupon bond (C=0)

𝑃 = 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,𝑛𝑦𝑟𝑠
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• Consider a 8 year , 12% bond with a par

value of Rs 100 on which interest is paid
semi annually. If the yield of the bond is
14% what is the intrinsic value of the
bond.

𝐶
𝑃 = ∗ 𝑃𝑉𝐼𝐴𝐹𝑟%,2𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟%,2𝑛𝑦𝑟𝑠
2 2 2
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12
𝑃= ∗ 𝑃𝑉𝐼𝐴𝐹14 + 100 ∗ 𝑃𝑉𝐼𝐹14
2 2 %,2∗8𝑦𝑟𝑠 2 %,2∗8𝑦𝑟𝑠

𝑃 = 6 ∗ 𝑃𝑉𝐼𝐴𝐹7%,16𝑦𝑟𝑠 + 100 ∗ 𝑃𝑉𝐼𝐹7%,16𝑦𝑟𝑠

= 90.6
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 Amity Business School

Intrinsic Value of Preference Shares

𝑃 = 𝐷 ∗ 𝑃𝑉𝐼𝐴𝐹𝑟𝑝 %,𝑛𝑦𝑟𝑠 + 𝑀 ∗ 𝑃𝑉𝐼𝐹𝑟𝑝 %,𝑛𝑦𝑟𝑠

• Compute the value of a preference stock 8

years ,10% with a par value of Rs 1000. The
required return on the preference stock is 9%
 Amity Business School

𝑃 = 100 ∗ 𝑃𝑉𝐼𝐴𝐹9%,8𝑦𝑟𝑠 + 1000 ∗ 𝑃𝑉𝐼𝐹9%,8𝑦𝑟𝑠

= 1055.5
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Equity Valuation : Dividend discount model (DDM)

For constant growth model

𝐷1
𝑃0 =
(𝑟 − 𝑔)
Where
𝐷1 = 𝐷0 (1 + 𝑔)
𝐷2 = 𝐷1 (1 + 𝑔)
𝐷2 = 𝐷0 (1 + 𝑔)2
𝐷𝑛 = 𝐷0 (1 + 𝑔)𝑛−1
 Amity Business School

Numerical
• Rainbow Engineering Ltd. Is expected to
grow at a rate of 6% per annum. The
dividend expected on company’s equity
share one year hence is Rs 2.What price
will you put on it if the required rate of
return for the share is 14%.
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2
𝑃0 =
(0.14 − 0.06)

= 25
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Two Stage growth model

(1 + 𝑔1 )𝑛
1− 𝑃𝑛
(1 + 𝑟)𝑛
𝑃0 = 𝐷1 +
𝑟 − 𝑔1 (1 + 𝑟)𝑛
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(1 + 𝑔1 )𝑛
1− 𝐷1 1 + 𝑔1 𝑛−1 (1 + 𝑔2 ) 1
(1 + 𝑟)𝑛
𝑃0 = 𝐷1 + ∗
𝑟 − 𝑔1 𝑟 − 𝑔2 (1 + 𝑟)𝑛
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𝑃0
(1 + 𝑔1 )𝑛 (1 + 𝑔2 )𝑛
1− 1−
(1 + 𝑟)𝑛 𝑛−1 (1 + 𝑟)𝑛
= 𝐷1 + 𝐷1 1 + 𝑔1 (1 + 𝑔2 )
𝑟 − 𝑔1 𝑟 − 𝑔2
𝐷1 1 + 𝑔1 𝑛 (1 + 𝑔2 )(𝑛+𝑚−1) (1 + 𝑔3 ) 1
+ ∗
𝑟 − 𝑔3 (1 + 𝑟)𝑛
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Numerical
The current dividend on an equity share of V Ltd is Rs 2 .
V ltd is expected to enjoy an above normal growth rate of
20% for a period of 6 yrs. Thereafter the growth rate will
fall and stabilize at 10%.Equity investors require a return
of 15%. What is the intrinsic value of the equity shares of
V Ltd
 Amity Business School

• 𝑔 1 : 20%

• 𝑔2 : 10%
• n : 6 yrs
• r : 15 yrs
• 𝐷1 : 2(1+.2) = 2.40

(1 + 𝑔1 )𝑛
1− 𝐷1 1 + 𝑔1 𝑛−1 (1 + 𝑔2 ) 1
(1 + 𝑟)𝑛
𝑃0 = 𝐷1 + ∗
𝑟 − 𝑔1 𝑟 − 𝑔2 (1 + 𝑟)𝑛
= 70.76
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H model

𝐷0 1 + 𝑔𝑛 + 𝐻(𝑔𝑎 − 𝑔𝑛 )
𝑃0 =
(𝑟 − 𝑔𝑛 )

H= N
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Numerical
• The current dividend on an equity share of Alpha ltd is
Rs 3.The present growth rate is 50% however it will
linearly decline over a period of 10yrs and stabilize at
12% . What is the intrinsic value of the shares of Alpha
ltd. If the investors require a return of 16%.
 Amity Business School

• 𝐷0 : 3
• 𝑔𝑛 : 12%
• 𝑔𝑎 : 50%
• 𝑟 : 16%
• 2H =10yrs
• H : 5 yrs

𝐷0 1 + 𝑔𝑛 + 𝐻(𝑔𝑎 − 𝑔𝑛 )
𝑃0 =
(𝑟 − 𝑔𝑛 )

= 226.5
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P/E ratio approach

𝑃0
𝑃0 = 𝐸1 ∗
𝐸1

𝐷1
𝑃0 =
(𝑟 − 𝑔)

𝐸1 (1 − 𝑏)
𝑃0 =
(𝑟 − 𝑏 ∗ 𝑅𝑂𝐸)
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𝑃0 (1 − 𝑏)
=
𝐸1 (𝑟 − 𝑏 ∗ 𝑅𝑂𝐸)

𝑃0 (1 − 𝑏)
=
𝐸1 (𝑟 − 𝑔)
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Equity Valuation : Capital Asset Pricing
model(CAPM)

CAPM

𝑅𝑖 = 𝑅𝑓 + (𝑅𝑚 − 𝑅𝑓 )𝛽𝑖
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Market Value of Firm

𝑉𝐹 = 𝑉𝐷 + 𝑉𝐸
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Economic Value Added

• Economic Value Added (EVA) is the net
operating profit minus an appropriate charge
for the opportunity cost of all capital invested
in an enterprise or project.
• It is an estimate of true economic profit, or
amount by which earnings exceed or fall short
of the required minimum rate of return
investors could get by investing in other
securities of comparable risk (Stewart, 1990)
Amity Business School
 Amity Business School
Numerical

NOPAT 2000000
WACC 10%
CE 750000
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NOPAT 2000000
WACC 10
CE 750000

EVA NOPAT-WACC*CE

1925000
 Amity Business School

2014 2015 2016

Capital invested (beginning
of year) $54,236 $50,323 $55,979

WACC 8.22% 8.28% 8.37%

NOPAT $7,265 $5,356 $4,336