Objectives

To find out the present value of Redeemable &

irredeemable preference shares To find out the present value of the ordinary share using: Dividend Capitalization Model

To

identify undervalued/overvalued shares by comparing present value with the market price of the share

The Objectives of Share Valuation

When the investors wants to sell the share, they need

to know the real intrinsic value of the share that they must realize In case of merger, joint venture or alliance, the companies need to go for share valuation in order to carry out their merger, joint venture or alliance Shareholders need to know the share valuation as they have to pay various relevant taxes like capital gains, capital transfer tax, and so on

Valuation of Preference Share

Redeemable Preference Share
Irredeemable preference share

Redeemable Preference Share

P0 = PDIV1 + PDIV2 + +PDIVn + Pn (1+kp)1 (1+kp)2 (1+kp)n (1+kp)n
n

P0 =

t=1

PDIV1 (1+kp)t

+ Pn
(1+kp)n

P0 = PDIV (PVFA n, i )

+ Pn (PVF n, i)

Redeemable Preference Share

The face value of a 9%prefrence share is Rs. 1,000. The maturity period is 5 years. The preference share will be redeemed at 5% premium on maturity. Calculate the present value of the preference share is the required rate of return is 10%.

Irredeemable Preference Share

P0 = PDIV Kp

You own 8%, 200, Rs. 100 par value irredeemable preference shares in AB limited. If the required rate of return on similar shares is currently 10%, what is the current value of your holding?

Valuation of Ordinary Shares

Single Period Valuation Growth in Share Price Multi-period valuation Growth Patterns of dividends

Zero Growth Normal Growth Super-normal Growth

Valuation of Ordinary Shares

Dividend Capitalization Model It was adopted and popularized by John Burr Williams. According to this model, the value of an equity share is equal to the present value of dividend expected from its ownership + the present value of the sale price expected when the equity share is sold The present value of share is determined by capitalizing/discounting the future dividends at the opportunity cost of capital

Dividend Capitalization Model

Assumptions: Dividends are paid annually The first dividend is received one year after the equity share is bought

Single-Period Valuation
When the investors expects to hold the equity share for one year, receive the dividend and then sell the equity share.
P0 = DIV1 + P1 (1 +Ke)

Where P0 Price of share today DIV1 Expected dividend after a year P1 Expected selling price of the equity share after a year Ke Opportunity cost of capital/Required rate of return

Growth in Share Price

P1 = P0 ( 1+g)

P0 = DIV1 + P0 ( 1+g) (1 +Ke)

By simplifying this equation, the share valuation can be found out from the following equation:

P0 =

DIV1 (Ke-g)

Single-Period Valuation
A companys share is having the expected dividend of Rs. 5 at the end of year and the expected selling price after a year is Rs. 110. If the required rate of return of the shareholders is 15%, what is the present value of the share?

Single-Period Valuation
An undervalued share has a market price less than the shares present value and an overvalued share has a market price higher than the shares present value.

Intrinsic Value
Rs. 100 Rs. 100 Rs. 100

MPS
Rs. 120 Rs. 80 Rs. 100

Comparison Result
MPS>I.V. MPS<I.V. MPS=I.V. Overvalued Undervalued Fairly Priced

Growth in Share Price

A companys share is being traded at Rs. 100. The dividend is expected to be Rs. 5.00 at the end of the year. The share price is expected to grow at 10%. If the required rate of return is 15%, what is value of share today?

Multi-Period Valuation
When the investor intends to hold the share for more than one year, and receive the dividend for those years and then liquidate the share, this is known as multiperiod valuation.

Multi-Period Valuation
P0 = DIV1 + DIV2 + + DIVn + (1 +Ke)1 (1 +Ke)2 (1 +Ke)n
n

Pn (1 +Ke)n

P0 =

t=1

DIVt (1+ke)t

+ Pn
(1+ke)n

Multi-Period Valuation
Bombay Ltd.s share is currently being traded at Rs.

100. The expected dividend at the end of the year is Rs. 5.00. The price of the share as well as the dividend is expected to grow at the rate of 10% p.a. what is the present value of the share, if the share is being held by an investor for 4 years. The required rate of return for the similar class of security is 15%.

Multi-Period Valuation
As the time horizon increases , the proportion of

present value of share price decreases and the proportion of dividend increases. Present value of future share price is almost negligible for 100 years time horizon. In principle, the time horizon n could be very large; in fact, it can be assumed to approach infinity (). If the time horizon, n, approaches to infinity, then the present value of the future price will approach to zero. Thus the price of a share today is the present value of an infinite stream of dividends.

Multi-Period Valuation
P0 = DIV1 + DIV2 + + DIVn= (1 +Ke)1 (1 +Ke)2 (1 +Ke)n=
n=

P0 =

t=1

DIVt
(1+ke)t

Growth in Dividends
Zero Growth
Normal/ Stable/Constant Growth Super normal Growth

Zero Growth in dividends

Zero growth in dividends mean that the dividend per share remains constant every year.
P0 = DIV1 + DIV2 + + DIVn + (1 +Ke)1 (1 +Ke)2 (1 +Ke)n P0 = DIV1 Ke

Normal Growth in dividends

DIV1= DIV0 (1+g)1 DIV2= DIV1 (1+g)1= DIV0 (1+g)2 P0 = DIV0 (1+g)1 + DIV0 (1+g)2 + (1 +Ke)1 (1 +Ke)2
n=

+ DIV0 (1+g)n= (1 +Ke)n=

P0 =

t=1
P0 =
P0 =

DIV0 (1+g)t
(1+ke)t

DIV0 (1+g) ke -g

DIV1 ke -g

Normal Growth in dividends

B Ltd.s equity share capital consist of 1,00,000 shares

of Rs. 10 each . The companys current dividend is Rs. 2/share which is expected to grow at 5% p.a. If the required rate of return in the same risk class of investment is 10%, what is the current value of a share of B Ltd. ?

Normal Growth
P0 =
P0 = P0 =
DIV1 ke -g

2.10 0.10 -0.05

2.10 0.05 Rs. 42

DIV0 DIV1 DIV1 DIV1

=2 = DIV0 (1+g) = 2 (1 +0.05) = 2.10

P0 =