Marks Breakup
Internals (40 marks)
15 marks Viva Voce
20 marks Group Project / Presentation
05 marks Class Attendance
Books
What is Value ?
Purpose of Valuation
The purpose of corporate valuation is
basically to estimate a fair market value of
a company.
Fair market value is the price at which the asset would
change hands between a willing buyer and a willing seller
when the former is not under any compulsion to buy and
the later is not under any compulsion to sell, both parties
having reasonable knowledge of relevant facts.
Caveats in Valuation
A valuation is an objective search for true value
All valuations are biased.
Bias in Valuation
Mitigation techniques
Avoid pre commitments
Delink valuation from reward /
punishment
Diminish institutional pressure
Increase self awareness
Uncertainty in Valuation
Sources of Uncertainty
Estimation uncertainty
Firm specific uncertainty
Macroeconomic uncertainty
Mitigation techniques
Better valuation models
Valuation ranges
Probabilistic Statements
Complexity in Valuation
The analysts can suffer from information
overload
Black box scenario The model becomes very
complex the analysts may not understand its
inner workings. They just feed input and get
the output.
.. if we can value an asset with three inputs we should not be
using five. If we can value a company with three years of cash
flow forecasts, forecasting 10 years cash flows is asking for
trouble. - Damodaran
Context of Valuation
Different Approaches to
Valuation
Intrinsic value approach (DCF)
Relative valuation approach
Option valuation approach
(1 r )
(1 r )
(1 r )
...
(1 r ) n
Expected Growth
Historical data
Management guidance
Reinvestments
WACC wE rE wD rD (1 T ) wP rP
where wE , wD and wP are the weights associated with equity, debt and preference
rE , rD and rP are the costs of equity , debt and preference.
Cost of Equity
CAPM
E(R i ) R f i [E(R m ) R f ]
where
E(R i ) is the exp ected return on sec urity i
R f is the risk free rate of return
Beta
Beta measures the volatility of the
stock with respect to the market
Dt
P0
t
t 1 (1 r )
D1
P0
rg
D0 (1 g)
D1
r
g
g
P0
P0
Growth rate (g) can be determined by
1. Analysts forecast
2. Historical Data
3. g = (retention rate)*(return on equity)
Cost of Debt
Cost of debt is nothing but the yield
to maturity of that instrument
Bank Loan
Debentures
n
P0
t 1
I
F
(1 rD )t (1 rD ) n
where
P0 is current market price of the debentureClose approximation can be given
I is the annual int erest payment
n is the number of years to maturity
F is the maturity value of debenture
rD is the cos t of debt
I ( F P0 ) / n
rD
0.6 P0 0.4 F
Cost of Debt
Commercial paper It is a short term
debt instrument which is issued at a
discount and redeemed at par. Hence
the cost of commercial paper is
simply is implicit interest rate.
Ex. The face value of a commercial paper
is 10,00,000 and it is traded in the market
at 9,65,000 with maturity of 6 months
Interest rate
10,00,000
1 0.0363 3.63%
9,65,000
Face Value
Market
Value
Coupon
Rate
YTM
Non
Convertible
Debenture
100 cr
104 cr
12%
10.7%
Bank Loan
200 cr
200 cr
13%
12%
Commercial
Paper
50 cr
48.25 cr
N.A.
7.39%
352.25 cr
104
200
48.25
12%
7.39% 10.98%
352.25
352.25
352.25
Cost of Preference
Preference capital carries a fixed rate
of dividend and is redeemable in
nature
Preference stock will be considered
much like a bond with fixed
commitments. However preference
dividend unlike debt interest is not a
tax deductible expense and hence
does not produce any tax savings.
WACC Example
Source of
capital
Proportion
Cost
Equity
0.60
16.0%
Preference
0.05
14.0%
Debt
0.35
12.0%
Weighted
Cost
CF to equity
Interest
Expense
50
40
60
40
68
40
76.2
40
83.49
40
Cost ofTerminal
Equity = 13.625% 1603
Cost of Debt
Value= 10%
Tax Rate = 50%
Total Debt = 800cr
CF to firm
2363