The document discusses various valuation models and approaches including discounted cash flow valuation, relative valuation, and contingent claim valuation. It provides examples of calculating enterprise value and weighted average cost of capital. It also summarizes the steps to conduct a discounted cash flow valuation, including forecasting free cash flows, determining the terminal value, and validating assumptions.

1. VALUATION OF SHARES Siddharth Jaiswal Shruti Telang Chirag Mehta Kruti Shah Heer Shah

3. CAPM P/E Ratio Gordon’s Model Dividend Growth Model Net Asset Value Liquidation Value Method DCF I need assistance EV

15. REPLACEMENT COST METHOD …For Adjusted Book Value Debtors Valued at Face Value. Provide for bad debts if doubtful. Inventories R.M. at most recent cost of acquisition WIP at Cost of R.M + Cost of processing FG at Realizable S.P – (holding, transport & selling costs) Other C.A. Other C.A. like deposits, prepaid expenses and accruals valued at Book Value Fixed Assets (Land, P&M, Buildings valued at Market Price ) + (transportation, installation & selling expenses if any). Non-operating assets Financial securities, excess land & buildings valued at Fair Market Value

16. … Replacement Cost per share Total assets at replacement cost Total liabilities (excluding networth) No. of Outstanding shares

18. … LIQUIDATION VALUE per share The value realized from liquidating all the assets of the firm. Less amount paid to all the creditors and preference share holders No. of outstanding shares

27. Valuation Models DCF Model Relative Valuation Model Equity / Balance Sheet Valuation Models Book Value Liquidation Value Replacement Cost P/E Ratio Economic Profit Model Entity DCF Model Dividend Models Dividend Discount Constant Growth DDM

28. Discounted Cashflow Valuation

41. Reliance has a beta of 1.5. Assuming the treasury rate as 5%. The cost of equity can be calculated as follows: Cost of Equity = 5% + (1.5 * 8%) = 17% The market premium of 8% was based upon historical data and is the premium earned by stocks on an average over treasury bills. The cost of equity of 17% will be used to discount dividends and cashflows to equity and to obtain the value of Reliance. Capital Asset Pricing Model Example: Reliance

46. DCF – Terminal value: exit multiple

47. DCF – Terminal value: perpetuity growth

49. DCF – Walmart example

51. Walmart FCF’s

52. Walmart continuation value

53. Walmart sensitivity analysis

54. Discounted Cashflow Valuation where, – n = Life of the asset – CFt = Cashflow in period t – r = Discount rate reflecting the riskiness of the estimated cashflows

56. Equity Valuation The value of equity is obtained by discounting expected cashflows to equity, i.e., the residual cashflows after meeting all expenses, tax obligations and interest and principal payments, at the cost of equity where, CF to Equity t = Expected Cashflow to Equity in period t ke = Cost of Equity Discounted Cashflow Valuation

57. Firm Valuation The value of the firm is obtained by discounting expected cashflows to the firm, i.e., the residual cashflows after meeting all operating expenses and taxes, but prior to debt payments, at the weighted average cost of capital, which is the cost of the different components of financing used by the firm, weighted by their market value proportions where, CF to Firm t = Expected Cashflow to Firm in period t WACC = Weighted Average Cost of Capital Discounted Cashflow Valuation

58. Assume that you are analyzing a company with the following cashflows for the next five years. Assume also that the cost of equity is 13.625% and the firm can borrow long term at 10%. (The tax rate for the firm is 50%.) The current market value of equity is $1,073 and the value of debt outstanding is $800. Discounted Cashflow Valuation Year CF to Equity CF to Firm 1 $ 50 $ 90 2 60 100 3 68 108 4 76.2 116.2 5 83.49 123.49 Terminal Value 1603.008 2363.008

59. Method 1: Discount CF to Equity at Cost of Equity to get value of equity Cost of Equity = 13.625% PV of Equity = 50/1.13625 + 60/1.13625 2 + 68/1.13625 3 + 76.2/1.13625 4 + (83.49+1603)/1.13625 5 = $1073 Method 2: Discount CF to Firm at Cost of Capital to get value of firm Cost of Debt = Pre-tax rate (1- tax rate) = 10% (1-.5) = 5% WACC = 13.625% (1073/1873) + 5% (800/1873) = 9.94% PV of Firm = 90/1.0994 + 100/1.0994 2 + 108/1.0994 3 + 116.2/1.0994 4 + (123.49+2363)/1.0994 5 = $1873 PV of Equity = PV of Firm - Market Value of Debt = $ 1873 - $ 800 = $1073

61. Effects of Mismatching Error 1: Discount CF to Equity at Cost of Capital to get equity value PV of Equity = 50/1.0994 + 60/1.0994 2 + 68/1.0994 3 + 76.2/1.0994 4 + (83.49+1603)/1.0994 5 = $1248 Value of equity is overstated by $175. Error 2: Discount CF to Firm at Cost of Equity to get firm value PV of Firm = 90/1.13625 + 100/1.13625 2 + 108/1.13625 3 + 116.2/ 1.13625 4 + (123.49+2363)/1.13625 5 = $1613 PV of Equity = $1612.86 - $800 = $813 Value of Equity is understated by $ 260. Error 3: Discount CF to Firm at Cost of Equity, forget to subtract out debt, and get too high a value for equity Value of Equity = $ 1613 Value of Equity is overstated by $ 540 Discounted Cashflow Valuation

63. Dividend Growth Model

64. Formula P o = Present Value of expected dividends = DPS / (k e – g) Where, P o = Price of stock today DPS = Expected dividends per share next year K e = Cost of equity g = growth rate in dividends A simple manipulation of this formula yields K e = ( DPS / p o ) + g Dividend Growth Model

65. In 1992, Southwestern Bell paid dividends per share of $ 2.82 and the stock traded at $66 in December 1992. The estimated growth rate in dividends was 5.5% and the firm is assumed to be in steady state. Expected dividends in 1993 = $ 2.82 * 1.055 = $ 2.98 Cost of Equity = $2.98 /$66 + 5.5% = 10% Dividend Growth Model Example: Southwestern Bell

66. Weighted Average Cost Of Capital

67. Cost of Debt After tax cost of debt = Pre tax cost of debt (1 – tax rate) Siemens AG had 4.244 bn DM of debt outstanding in July 1993. Due to its low leverage and substantial cash balances, its default risk was minimal at it could borrow at 6.72%. The tax rate it faced was 38%. After tax cost of debt = 6.72%(1-0.38) = 4.17% WACC

68. Cost of Preferred Stock K ps = Preferred Dividend per share / Mkt price of preferred share At the end of 1992, GM had preferred stock which paid a dividend of $ 2.28 annually and traded at $ 27. Kps = $2.28/$27 = 8.44% WACC

69. WACC: Pepsi Example WACC = k e (E/[E+D+PS]) + K d (D/[E+D+PS]) + K ps (PS/[E+D+PS]) In Dec 1992, Pepsi Cola Corp had a cost of equity of 12.83% and after tax cost of debt of 5.28%. Equity = 76.94% Debt = 23.06% WACC = (12.83% * 0.7694) + (5.28% * 0.2306) = 11.09% WACC

72. Dividend Discount Models

74. The General Model

77. The Gordon Growth Model

81. Two Stage Dividend Discount Model

83. Extraordinary growth rate g % each year 1 2 3 4 5 6….. Stable growth for ever PV of dividends during extraordinary growth period + PV of terminal price The Two Stage Dividend Discount Models

86. H Model

88. g a g n Extraordinary growth 2H yrs Infinite growth H Model

93. Three stage DDM

95. High growth Transition Infinite growth g a g n Low payout ratio Increasing P/o High P/o Three Stage Dividend Discount Model

96. Formula Three Stage Dividend Discount Model

98. THE H-MODEL AND THREE STAGE MODEL … Relation Between The Two

104. FCFE Valuation Models

110. 2 Stage FCFE Model

114. Example: Amgen Inc. – 1993-94 PV of FCFE during high growth phase = 2.54+2.63+2.72+2.82+2.92 = $13.64 2 Stage FCFE Model ($) Year 1 Year 2 Year 3 Year 4 Year 5 Earnings 3.68 4.37 5.19 6.17 7.33 (-)(Capex-Dep.)* (1-1.3) 0.39 0.46 0.55 0.65 0.78 (-)(Chg.in WC)* (1-1.3) 0.38 0.45 0.54 0.64 0.76 = FCFE 2.91 3.46 4.11 4.88 5.79 Present Value (14.65%) 2.54 2.63 2.72 2.82 2.92

117. Price/Earnings Multiples

121. Price/Book Value Multiples

126. PBV Ratio - ROE Price/Book Value Multiples ROE – Required Return PBV Ratio High High Low Overvalued Low ROE – High PBV High ROE – High PBV Low ROE – Low PBV Undervalued High ROE – Low PBV

127. Price/Sales Multiples

132. P/E & Growth Ratio

134. Year-ahead P/E & Growth Ratio

139. FINANCIAL DATA …Tata Steel Industry avg PE : 10.3 Tata Steel PE : 5.8 Economy Growth Rate : 7.0% Risk Free Rate of Return : 6.25%(Reserve Bank of India) Beta (ß) for Tata Steel : 1.13 (besindia.com) FY00-01 FY01-02 FY02-03 FY03-04 FY04-05 Equity Share Cap 3,679.70 3,679.70 3,679.70 3,691.80 5,536.70 Res & Surplus 43,804.60 30,779.90 28,168.40 41,466.80 65,062.50 No. of Equity shares o/s 367,771,901 367,771,901 367,771,901 367,771,901 553,472,856 Dividend/ Share 5.00 4.00 8.00 10.00 13.00

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