In this component we have basically valuated the securities of our company using various

models

And then we have calculated the cost of capital of the company

RELATIVE VALUATION

Under relative valuation we take all the companies in the industry to compute the present
share price of our company. We calculate various ratios such P/E, P/BV and P/S

P/E ratio reflects the amount the investors are willing to pay for each rupee of earnings. The
EPS of our firm is multiplied with the average P/E ratio of the industry to estimate the share
value of the firm on the investors value the earnings of the firm the same way as they do for the
average firm in the industry.

But since there are many firms in the specific industry , our may not be at the same level in
terms of earnings as the other firms, i.e our firm might be at the top level or at the bottom
level. So in order to get the exact price of our firm we have considered the average of only
those firms who are at par with our firm

For eg. Since ICICI is a one of the top banks we have compared it with the other top banks in the
industry such as PNB , Axis bank , HDFC, SBI etc. and hence we haven’t taken the average P/E of
the entire industry and just considered the average P/E of these few firms.

This gave us a closer approximation to the share price of our company.

Similarly we calculated the share prices based on the other ratios as well

The P/BV ratio or the Book Value approach is not a good proxy for true investment value
because:

1. This approach relies on historical data

2. It ignores the expected earning potential
3. The BVPS ( net worth/no of shares) has no true relation to the market value of the firm.

Once we calculate all the ratios based on the average of few firms we get a range of share
price of the company. And the average of this range will give a good approximation to the
actual present value of the share price

WE also calculated the share price using DIVIDEND DISCOUNT MODEL

Under this we have taken 3 models of growth: Zero growth , constant growth and supernormal
growth model

In order to evaluate these models we require the required rate of return for all the firms

Hence we used the best MODEL of CAPITAL ASSET PRICING MODEL to calculate ke.

The formula states : ke = Rf+(Rm-Rf)*Beta

When we calculated ke taking into account the last 5 yrs we got a negative value for it. This occurred
because of the inconsistencies in the share prices of the market and firm during the last 5 yrs due to
the changing periods of recession and then boom. Hence we need to assume this value of ke based
on the value of the cost of debt obtained.

Since cost of equity is higher than cost of debt we take ke around 3 to 4% higher than kd to continue
our calculations

Risk free rate is obtained from government issued T-bills. The risk free rate is taken as 8%

The value of cost of equity or the required rate of return can be calculated using CAPM.

In constant growth model we have calculated the GROWTH in dividends for all the 5 firms using the
formula :

Growth = ROE * r

Where ROE : Return on equity

R : Retention ratio

Hence we calculated the present value of the shares using the constant growth model.

Under supernormal growth,

1. Patni computers : being an IT industry it contributes a lot to the country s economy. Assuming
that the economy of the country will grow in the near future it will not be wrong to assume a
supernormal growth of Patni computers in the near future. \
2. Apollo Hospitals : with the increase of people s income they have started preferring the best
treatment that they can get. And Apollo is one of the top most health service firm in the
industry. Hence we have assumed a growth of Apollo as well in the near future
3. ICICI Bank
4. SAIL : steel industries definitely contribute to country s growth. For the constructions made by
government for the betterment of the people steel forms and important part. So with the
growth of the economy there would be a supernormal growth of SAIL in the near future.
5. Hero Honda : with people preferring more of 4 wheelers now, there are chances of the growth
of 2 wheelers to fall down. But Hero Honda can being a famous brand can maintain their
growths in the economy. It might rise in the later periods due to continuous advent of new and
stylish bikes

Hence considering all these factors it was easy to compute the share price of the firm.

DDM does not give a very good approximation of the share prices when compared to relative
valuation method since there is a lot of variation in the dividends given per year. Moreover the value
of ke is difficult to determine.

Once the share prices have been valued we need to calculate the weighted average cost of capital
taking into account the various sources of funds taken by the firm

The various sources of funds can be :

1. Equity
2. Retained earnings
3. Debentures
4. Long term loans
5. Preference shares

Depending on the firm and their sources of fund we need to calculate the cost of capital of each.