Ch.

3: Valuation of Bonds and Shares

CHAPTER 3

VALUATION OF BONDS AND SHARES

Problem 1

(1) 1-year government bond maturity value (Rs) 1,000

Market rate of interest 8%
PV of the bond: 1,000/1.08 (Rs) 925.93
(2) Purchase price of bond (Rs) 904.98
Implied return: (1,000 – 904.98)/904.98 10.5%

Problem 2

Perpetual interest (Rs) 140

Current yield 0.13
Price of bond (B) (Rs) 1076.92
140
B= = 1076.92
0.13
Required rate 0.15
New price of bond (B) (Rs) : 933.33
140
B= = 1076.92
015
.

Problem 3

Face value (Rs) 1000

Annual interest 140
Maturity (years) 10
Maturity value (Rs) 1000
Required rate 0.12 0.14 0.16
PVAF, 10 year 5.6502 5.2161 4.8332
PVF, 10 year 0.3220 0.2697 0.2267
PV of interest (Rs) 791.03 730.26 676.65
PV of maturity value (Rs): (d x g) 321.97 269.74 226.68
PV of 10-year debenture (Rs) 1113.00 1000.00 903.34
n =10

∑ (1.12)
140 t 1,000
PV of 10 - year bond = +
t =1
t
. ) 10
(112
= 140 × PVAF.12, 10 + 1,000 × PVF.12, 10
= 140 × 5.6502 + 1,000 × 0.3220 = Rs 1,113.00
Similar calculations can be made if the required rate is 14% or 16%.
What would happen to the present value of bond if it had a maturity of 5 years? A similar procedure can be followed.
PV of a 5-year bond at 12%, 14% and 16% respectively will be as shown below:

Required rate 0.12 0.14 0.16

PVAF, 5 year 3.6048 3.4331 3.2743
PVF, 5 year 0.5674 0.5194 0.4761
PV of interest (Rs) 504.67 480.63 458.40
PV of maturity value (Rs) 567.43 519.37 476.11
PV of 5-year debenture (Rs) 1072.10 1000.00 934.51

Problem 4

Face value (Rs) 1000

Interest rate 0.16
Interest (Rs): (1,000 x 0.16) 160
Price of bond (Rs) 800 1300 1000
Yield = INT B 0.200 0.123 0.160

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 5
Taxco (three-year maturity):
Cash PVF PV PVF PV PVF PV
flow 9% (Rs) 12% (Rs) 6% (Rs)
120 0.917 110.09 0.893 107.14 0.943 113.21
120 0.842 101.00 0.797 95.66 0.890 106.80
1120 0.772 864.85 0.712 797.19 0.840 940.37
1075.94 1000.00 1160.38

Maxco (three-year maturity):

Cash PVF PV PVF PV PVF PV
flow 9% (Rs) 12% (Rs) 6% (Rs)
60 0.917 55.05 0.893 53.57 0.943 56.60
60 0.842 50.50 0.797 47.83 0.890 53.40
1060 0.772 818.51 0.712 754.49 0.840 890.00
924.06 855.89 1000.00

Taxco (eight-year maturity):

Cash PVF PV PVF PV PVF PV
flow 9% (Rs) 12% (Rs) 6% (Rs)
120 0.917 110.09 0.893 107.14 0.943 113.21
120 0.842 101.00 0.797 95.66 0.890 106.80
120 0.772 92.66 0.712 85.41 0.840 100.75
120 0.708 85.01 0.636 76.26 0.792 95.05
120 0.650 77.99 0.567 68.09 0.747 89.67
120 0.596 71.55 0.507 60.80 0.705 84.60
120 0.547 65.64 0.452 54.28 0.665 79.81
1120 0.502 562.09 0.404 452.35 0.627 702.70
1166.04 1000.00 1372.59

Maxco (eight-year maturity):

Cash PVF PV PVF PV PVF PV
flow 9% (Rs) 12% (Rs) 6% (Rs)
60 0.917 55.05 0.893 53.57 0.943 56.60
60 0.842 50.50 0.797 47.83 0.890 53.40
60 0.772 46.33 0.712 42.71 0.840 50.38
60 0.708 42.51 0.636 38.13 0.792 47.53
60 0.650 39.00 0.567 34.05 0.747 44.84
60 0.596 35.78 0.507 30.40 0.705 42.30
60 0.547 32.82 0.452 27.14 0.665 39.90
1060 0.502 531.98 0.404 428.12 0.627 665.06
833.96 701.94 1000.00

Problem 6
(1) Annual compounding: Annual interest rate 12%

Dis. rate - annual 10% 12% 16%

Cash
Period flow PVF PV PVF PV PVF PV
1 to 5 120 3.791* 454.89 3.605 432.57 3.274 392.92
5 1,000 0.621 620.92 0.567 567.43 0.476 476.11
1075.82 1000.00 869.03
* Annuity factor

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Ch. 3: Valuation of Bonds and Shares

(2) Half-yearly compounding: Half-yearly interest rate 6%

Dis. rate -half-yearly 5% 6% 8%
Period Cash flow PVF PV PVF PV PVF PV
1 - 10 60 7.722* 463.30 7.360 441.61 6.710 402.60
10 1,000 0.614 613.91 0.558 558.39 0.463 463.19
1077.22 1000.00 865.79
* Annuity factor
(3) Quarterly compounding: Quarterly interest rate 3%
Dis. rate -half-yearly 2.5% 3% 4%
Period Cash flow PVF PV PVF PV PVF PV
1 - 20 60 15.589* 935.35 14.877 892.65 13.590 815.42
20 1,000 0.610 610.27 0.554 553.68 0.456 456.39
1545.62 1,446.33 1,271.81
* Annuity factor

Problem 7

Face value Rs 1,000

Maturity periods (half-yearly) 20
Half-yearly interest rate 6%
Interest payment period 11 - 20
Maturity value Rs 1,050
Required rate (half-yearly) 7%
Value of interest (Rs) 214.23
Value of maturity value (Rs) 271.34
Value of bond (Rs) 485.57
20

∑ (1.07)
60 t 1,050
Value of bond = t
+
t =11
(1.07) n
(
= 60 × PVAF20,7% − PVAF10,7% + 1,050 × PVF20,7% )
= 60 × (10.5940 − 7.0236) + 1,050 × 0.2584 = Rs 485.57
Problem 8

Bond 1 Bond 2 Bond 3 Bond 4

Interest rate 16% 14% 12% 12%
Required rate of return 15% 13% 8% 8%
Maturity period (years) 25 15 20 10
Par/maturity value (Rs) 100 100 100 100
Semi-annual interest rate 8.0% 7.0% 6.0% 6.0%
Required rate of return (half-yearly) 7.5% 6.5% 4.0% 4.0%
Compounding periods 50 30 40 20
PVAF (annuity) 12.9748 13.0587 19.7928 13.5903
Half-yearly interest (Rs) 8 7 6 6
PV of interest (Rs) 103.80 91.41 118.76 81.54
PVF (lump sum) 0.0269 0.1512 0.2083 0.4564
PV of maturity value (Rs) 2.69 15.12 20.83 45.64
Bond value (Rs) 106.49 106.53 139.59 127.18
Current market price of bonds (Rs) 95 100 110 115
Annual yields (by trial & error) 16.86% 14.00% 10.76% 9.60%
Semi-annual yield (by trial & error) 8.43% 7.00% 5.39% 4.82%

Value of a bond that pays interest half-yearly can be calculated by the following equation:
2n 1

∑ 2 (INTt ) Bn
B0 = kd
+ kd 2 n
t
t =1 (1 + 2 ) (1 + 2 )

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 9

1 - year bond
(i) Annual yield
10 + 100
95 = = 15%
1+ y
(ii) Half - yearly yield
5 5 + 100
95 = + = 7.8%
1 + y (1 + y) 2
2 − year bond
(i) Annual yield
10 10 + 100
100 = + = 10%
1 + y (1 + y) 2
(ii) Half - yearly yield
5 5 5 5 + 100
100 = + + + = 5%
1 + y (1 + y) 2 (1 + y)3 (1 + y) 4
3 − year bond
(i) Annual yield
10 10 10 + 100
110 = + + = 6.24%
1 + y (1 + y) 2 (1 + y)3
(ii) Half - yearly yield
5 5 5 5 5 5 + 100
110 = + + + + + = 3.15%
1 + y (1 + y) 2 (1 + y)3 (1 + y) 4 (1 + y)5 (1 + y) 6
4 − year bond
(i) Annual yield
10 10 10 10 + 100
115 = + + + = 5.70%
1 + y (1 + y) 2 (1 + y)3 (1 + y) 4
(ii) Half - yearly yield
5 5 5 5 5 5 5 5 + 100
115 = + + + + + + + = 2.87%
1 + y (1 + y) 2 (1 + y)3 (1 + y) 4 (1 + y) 5 (1 + y) 6 (1 + y) 7 (1 + y)8

Problem 10

20 − year bond redeemable in 12 years : Half - yearly interest 5%; periods 24

24

∑ (1 + YTC)
50 t 1,150
1,000 = t
+
t =1
(1 + YTC) n
YTC = 5.32%
24

∑ (1 + YTC)
50 t 1,100
1,000 = t
+
t =1
(1 + YTC) n
YTC = 5.22%
20 − year bond redeemable in 8 years : Half - yearly interest 5%; periods 16
16

∑ (1 + YTC)
50 t 1,150
1,000 = t
+
t =1
(1 + YTC) n
YTC = 5.60%

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Ch. 3: Valuation of Bonds and Shares

Problem 11

Annual interest rate 15%

Quarterly interest rate 3.75%
Market price (Rs) 875
Maturity value (Rs) 1000
Quarterly periods 60
New interest rate 12.0%
New quarterly interest rate 3.0%
Stated yield
Quarterly interest (Rs) 37.50
Market price (Rs) 875.00
Quarterly yield 4.34%
Expected yield
Quarterly interest (Rs) 30.00
Market price (Rs) 875.00
Quarterly yield 3.50%

Quarterly yields can be found by trial and error. You can also use the Excel formula for rate to calculate yield:
= RATE(nper,pmt,pv,[fv],[type],guess)

Problem 12

Value of perpetual preference share =12/0.10 = Rs 120

7

∑ (1.10)
12 t 110
Value of redeemable preference share = t
+
t =1
(1.10) 7
= 12 × PVAF7,10% + 110 × PVF7,10%
= 12 × 4.868 + 110 × 0.513 = Rs114.87
You can use the Excel formula to calculate value of redeemable preference share:
=PV(rate,nper,pmt,[fv],[type])

Problem 13

Expected DPS (Rs) 3.00

Current share price (Rs) 50.00
Share price after 1 year (Rs) 53.00
Required rate 0.10
PV of share (Rs):
DIV1 + P1 3 + 53
P= = 50.91
(1 + k e ) 1 11
.
Return on share:
DIV1 + ( P1 − P0 ) 3 + 53 − 50
re = = = 0.120
P0 50

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 14

Share price (Rs) 75.00

Capitalisation rate 0.12

DPS Share price PVF PV

Year (Rs) (Rs) at 12% (Rs)
0
1 7.50 0.8929 6.70
2 7.50 0.7972 5.98
3 9.00 0.7118 6.41
4 15.00 0.6355 9.53
4 70.00 0.6355 44.49
Value of the share 73.10

It is a desirable investment since the present value of the share is more than its current price.

Problem 15

Current share price 60.00

DPS 1.50
Growth rate 0.10
Required rate 0.12
Value of the share:
DIV1
P0 =
ke − g
15
. (11
.) 1.65 82.50
= =
0.12 − 0.10 0.02
Share should be bought

Problem 16

Earnings growth up to 7 years 0.15

Perpetual growth after 7 years 0.09
Required rate for 7 years 0.12
Required rate after 7 years 0.10
EPS 4.00
DPS 2.00

DPS PVF PV
Year (Rs) @ 12% (Rs)
0 2.00
1 2.30 0.8929 2.05
2 2.65 0.7972 2.11
3 3.04 0.7118 2.17
4 3.50 0.6355 2.22
5 4.02 0.5674 2.28
6 4.63 0.5066 2.34
7 5.32 0.4523 2.41
15.58

Present value of dividend growing DIV7 (1 + g n ) 5.32(1.09)

perpetually after 7 years P7 = = = Rs 579.88
ke − gn 0.10 − 0.09

PV of Rs 579.88 579.88
= 579.88 × 0.5132 = Rs 297.57
(1.10) 10
Value of share 15.58 + 297.57 = Rs 313.16

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Ch. 3: Valuation of Bonds and Shares

Problem 17

(Rs)
Current EPS 5.00
Retention ratio, b 0.60
Current DPS, DIV0 = EPS0(1 - b) 2.00
Rate of return, r 0.15
Required rate, ke 0.13
Current share price (Rs) 60.00
Growth, g = b x r 0.09
Expected EPS (Rs): EPS1 = EPS0(1+g) = 5 x 1.09 5.45
Expected DPS (Rs): DIV1 = DIV0(1+g) = 2 x 1.09 2.18
Expected retained earnings, RE1 = EPS1 - DIV1 3.27
Value of share if g = 0
EPS1 5
P0 = = 41.92
k e − g 0.13 − 0
Value of share if g = 9%
DIV1 2(1+.09) 2.18
P0 = = = 54.50
k e − g 0.13−.09 0.04
Value of growth opportunities, Vg (Rs): 54.50 - 41.92 12.58
The following formula can be used to find Vg:
RE 1 ( r − k e ) 3.27(.15−.13) .0654
Vg = = = 12.58
k e ( k e − g) .13(.13−.09) .0052

Problem 18

Total assets Rs 80,000

Equity Rs 80,000
Number of shares 10,000
Equity per share: 80,000/10,000 Rs 8
Internal rate of return, r 10%
Earnings: 10% × 80,000 Rs 8,000
EPS Rs 0.8
Capitalisation rate, k 12%
Retention ratio, b 70%
Dividend per share, DIV: 30% × 0.8 Rs 0.24
Growth rate, g: b × r 7%
Expected DIV: 0.24 × 1.07 Rs 0.2568
PV of share: 0.2568/(0.12 – 0.07) Rs 5.14

Problem 19

Last year's DPS (Rs) 3

Current market price (Rs) 80
Required rate 0.1
Scenario 1: Scenario 2: Scenario 3:
No growth Perpetual growth Different growth rates
Growth rate 0 0.06
Value of share (Rs) 3/.10=30 3(1.06)/.1 - .06 = 79.5 68.84 (see below)

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Scenario 3: Different growth rates

Growth rate Year DPS (Rs) PVF PV (Rs)
1-3 years 0.12 0 3.00
4-6 years 0.07 1 3.36 0.9091 3.05
7 year and onwards 0.04 2 3.76 0.8264 3.11
3 4.21 0.7513 3.17
4 4.51 0.6830 3.08
5 4.83 0.6209 3.00
6 5.16 0.5645 2.91
PV of DPS at 10% from year 1 to 6 18.32
PV of DPS growing perpetually at the
end of 6 years: 5.16(1.04)/(.1 - .04) 7 5.37 16.667 89.50
PV of value of Rs 89.50 received at
the end of 6th year: 89.5 x 0.5645 0.5645 50.52
Value of share (Rs): 18.32 + 50.42 68.84

Problem 20

Current DPS (Rs) 5

Current growth rate 0.05
New growth 0.10
Capitalisation rate 0.15
Share price (Rs) if g = 5%, [5(1.05)/(0.15-.05)] 52.50
Share price (Rs) if g = 10%, [5(1.1)/(0.15-0.1)] 110

When the firm’s growth increases from 5% to 10%, the share prices rises from Rs 52.50 to Rs 110. It is quite logical
since price depends on expected dividend and future growth opportunities.

Problem 21

Face value (Rs) 10

Market
EPS Dividend price DPS Earnings Dividend
(Rs) rate (Rs) (Rs) Payout yield yield
Bajaj 11.9 0.50 275.0 5.0 0.420 0.0433 0.0182
Hero Honda 10.2 0.22 135.0 2.2 0.216 0.0756 0.0163
Kinetic 12.0 0.25 177.5 2.5 0.208 0.0676 0.0141
Maharashtra.
Scooters 20.1 0.25 205.0 2.5 0.124 0.0980 0.0122

Bajaj has the highest current share price but it also pays maximum dividend (as a percentage of its earnings). On the
other hand, Maharashtra Scooters has maximum EPS, lowest payout, lowest dividend yield and it is ranked third in
terms of share price. Hero Honda has lowest EPS and lowest share price. Kinetic ranks at third place in terms of EPS,
DPS and share price. It appears that the market is giving consideration to the companies’ current performance as well
as future growth prospects.

Problem 22

DPS in year 0 (Rs) 3.5

DPS in year 10, (Rs) 10.5
Period (years) 10
Dividend growth rate: [(10.5/3.5)1/10 -1] 0.1161
Share price (Rs) 75
Expected dividend yield [3.5(1.1161)/75] 0.0521
Capitalisation rate: 0.1161 + 0.0521 0.1682

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Ch. 3: Valuation of Bonds and Shares

Problem 23

Current EPS (Rs) 8.60

Growth 0.12
Payout 0.40
Retention ratio: 1 - .4 0.60
Capitalisation rate 0.18
DPS (Rs) 3.44
Expected EPS: 8.6 x 1.12) 9.63
Expected dividend: 3.44 x1.12 3.85
Expected retained earnings: 9.63 x 0.60 5.78
Share value (12% growth) (Rs) 64.21
Share value (no growth) (Rs) 53.51
Firm's rate of return:
g=r×b
r = g / b =.12 /.6 0.20
Value of growth opportunities:
RE 1 ( r − k e ) 5.78(.20−.18) .1156
Vg = = = 10.70
k e ( k e − g) .18(.18−.12) .0108

Problem 24

12% 14% Pref. Equity

debenture debenture share share
Face value (Rs) 1000 1000 100 100
Interest or dividend rate 12% 14% 15%
Payment frequency annual half-yearly annual annual
Maturity (years) 12 10
Compounding periods 12 20
Maturity value (Rs) 1000 1000
Principal amount (Rs crore) 50 30 100 200
Required rate of return 0.10 0.06 0.135 0.15
PVAF (annuity) 6.8137 11.4699
PVF (lump sum) 0.3186 0.3118
Interest/dividend amount (Rs) 120 70 15 12
Perpetual growth rate 0.08
Market value of each 120 x 6.8137 70 x 11.4699
debenture or share (Rs) + 1000 x .3186 + 1000 x .3118 15/.135 12/(.15 - .08)
= 1136.27 = 1114.69 = 111.11 = 171.43
Total market value (Rs crore) 56.81 33.44 111.11 342.86

Problem 25

Net profit (Rs crore) 50

Number of shares (crore) 2
EPS: 50/2, Rs 25
ROE 25%
Capitalisation rate, k 12%
Payout 60%
Retention ratio, b (1 – payout) 40%
Dividend per share, DIV: 60% × 25 15
Growth rate, g: b × r: 40% × 25% 10%
Expected DIV: 25 × 1.10 16.5
Current share price, P0 240
Expected dividend yield: DIV1/ P0 6.88%
Capitalisation rate, k = (DIV1/ P0) + g 16.88%

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Problem 26

Net earnings (Rs million) 25

Paid-up capital (Rs million) 200
Par value of share (Rs) 10
Number of shares: paid-up capital/par value of share (mn.) 20
EPS = dividend per share, DIV (assumed): 25/20 1.25
Growth (without investment) 2%
Opportunity cost of capital 10%
Share price: P0 = (1.25 × 1.02)/ (0.10 – 0.02) 15.94
Investment (Rs million) 10
Earnings from investment (Rs million) 2
Life of investment, years 15
Investment’s NPV: PV of Rs 2 million for 15 years at 10%: 2*7.6061-10 5.21
Share price (with investment): 15.94 + 5.21 (million) 21.15

Problem 27

Earnings (without project), Rs crore 80

Number of shares, crore 5
EPS: 80/5 16
Required rate of return 12.50%
Share price (without project): 16/0.125 128
Earnings from project after one year 20
EPS from project: 20/5 4
Growth in earnings from project after one year 8%
Required rate of return 12.50%
Value of growth opportunities: 4/(0.125 – 0.08) 88.89
Share value with project: 128 + 88.89 216.89
EPS after project 20
P/E ratio: 216.89/20 10.84

Problem 28

Number of shares, million 10

Net cash profits, Rs million 80
Cash EPS: 80/10 8
Opportunity cost of capital 20%
(a) (i) Retention ratio 40%
Return on retained earnings 20%
Growth: 40% × 20% 8%
Expected Dividend per share, DIV1: 8 × (1 – 0.40) × 1.08 5.18
Share price: 5.18/(0.20 – 0.08) 43.20
(a) (ii) Retention ratio 60%
Return on retained earnings 20%
Growth: 60% × 20% 12%
Expected Dividend per share, DIV1: 8 × (1 – 0.60) × 1.12 3.58
Share price: 3.58/(0.20 – 0.12) 44.80
(b) (i) Retention ratio 40%
Return on retained earnings 24%
Growth: 40% × 24% 9.60%
Expected Dividend per share, DIV1: 8 × (1 – 0.40) × 1.096 5.26
Share price: 5.26/(0.20 – 0.096) 50.58
(b) (ii) Retention ratio 60%
Return on retained earnings 24%

Growth: 60% × 24% 14.40%

Expected Dividend per share, DIV1: 8 × (1 – 0.60) × 1.144 3.66
Share price: 3.66/(0.20 – 0.144) 65.37

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Ch. 3: Valuation of Bonds and Shares

Problem 29

Cash EPS (perpetuity), Rs 10

Payout 100%
DIV, Rs 10
Opportunity cost of capital 15%
(a) Share price: 10/0.15 66.67
(b) Expansion opportunity
Earnings retention 50%
Rate of return 18%
Growth: 50% × 18% 9%
DIV1: 5 × 1.09 5.45
Period of growth 10
Value of growth opportunity:
 1   1 + g  n 
V = DIV1 ×  × 1 −   
 k − g   1 + k  
  
 1   1.09 10 
= 5.45 ×  × 1 −   
 0.15 − 0.09   1.15  
  
= 5.45 × 16.67 × 0.4148 = Rs 37.68
Value after growth opportunity: (10×1.0910/0.15) 157.80
PV after growth opportunity: 157.80 × 1/1.1510 39.01
Total share price with growth opportunity: 37.68 + 39.01 76.69

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

CASES
Case 3.1: Shyamulu Rao's Investment Decision

This case brings out most of the concepts in valuation of shares and bonds. The instructor can ask the
students to make the appropriate calculations, and spend the class time in clarifying the concepts and
doubts that the students might have.

Return from investment in share

Investment amount (Rs) 50,000
Required rate of return 15%
Holding period (years) 10
Investment per share 20
Expected EPS1 (Rs) 3
ROE 15%

(i) No dividend situation 0 Required price for earning 15% return:

Expected EPS1 (Rs) 3 Investment per share 20
Retention 100% Dividend per share 0
Growth 15.0% Required rate of return 15%
No growth share price 20.00 Holding period (years) 10
Value of growth opportunities 0.00 PVF10, 15% 0.2472
Share price, P0 20.00 Required price at year 10 80.91

Required price for earning 15% return:

(ii) Constant dividend (Rs) 3 Investment per share 20
Retention 0% Dividend per share 3
Growth 0% Required rate of return 15%
Share price, P0 20.00 Holding period (years) 10
PVAF10, 15% 5.019
PV of DPS (Rs) 15.06
PVF10, 15% 0.2472
Required price at year 10 20.00

Required price for earning 15% return:

(iii) Dividend per share 1 Investment per share 20
Retention 67% Dividend per share 1
Growth 10% Growth 10%
Share price, P0 20.00 Required rate of return 15%
Holding period (years) 10
PVAF10, 15%, (growth rate 10%) 7.1773
PV of DPS (Rs) 7.18
PVF10, 15% 0.2472
Required price at year 10 51.87

(iv) Dividend per share 1.6 Required price for earning 15% return:
Supernormal growth 15% PVF PV
DPS1 1 1.60 0.870 1.39
DPS2 2 1.84 0.756 1.39
DPS3 3 2.12 0.658 1.39

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Ch. 3: Valuation of Bonds and Shares

DPS4 4 2.43 0.572 1.39

DPS5 5 2.80 0.497 1.39
Value in year 0 6.96
Normal growth 10%
Value at year 5 61.57
Value at year 0 30.61
Share price 37.57

PV
Investment per share 20 Year DIV PVF (DIV)
Dividend per share 1.00 6 3.08 0.4323 1.33
Required rate of return 15% 7 3.39 0.3759 1.27
Supernormal growth 15% 8 3.73 0.3269 1.22
Supernormal growth period (yrs) 5 9 4.10 0.2843 1.17
PV supernormal growth period 6.96 10 4.51 0.2472 1.11
Normal growth 10% 6.10
Normal growth period (yrs) 5
PV normal growth period 6.10
PVF10, 15% 0.2472
Required price at year 10 28.08

Government bond
Redemption value of bond 10,000
Current value of bond 2720
Implied IRR 13.9%

Reliable Fertiliser bond

Implied return
0 -1000
1 150
2 150
3 150
4 150
5 150
6 150
7 150
8 150
9 150
10 1250
IRR 15.5%

Shyamulu will be able to earn 15.5% - more than his required rate of return from bonds of Reliable Fertiliser Company.
His risk in investing in bonds would be lower than investing in shares of Ashoka Infotech.

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I. M. Pandey, Financial Management, 9th Edition, New Delhi: Vikas.

Case 3.2: Hitech Chem Limited

This case highlights the alternative methods of valuing a company and its shares.

Issue price (Rs) 13

P/E ratio 18.5
P/E ratio - industry 21.75
P/E ratio - Chemical 15
Annual capex (Rs million) 300
S L depreciation rate 10%
Average sales (Rs million) 15,000
Current sales (Rs million) 21,500
PBIT/sales ratio 22%
Revaluation of tangible fixed assets (Rs million) 6,500
Tax rate 35%
Expected Conservative
Hitech's EPS (Rs mn.) (Rs mn.)*
Current sales 21,500 16,125
PBIT 4,730 3,548
Interest - 15% bank loan 210 210
Interest - 12% long-term loan loan 360 360
PBT 4,160 2,978
Tax 1,456 1,042
PAT 2,704 1,935
Number of share 750 750
EPS (Rs) 3.61 2.58
* Lost sales due to patents expiry
Hitech's Valuation
(i) Book value of equity (equals net worth) (Rs mn.) 13,500
Number of share 750
Book value per share (Rs) 18.00
(ii) P/E based value
PAT (Rs mn.) 2,704 1,935
Hitech's P/E ratio 18.50 18.50
Equity value (Rs mn.) 50,024 35,804
EPS (Rs) 3.61 2.58
Equity value per share (Rs) 66.70 47.74
Chemical industry's P/E ratio 15.00 15.00
Equity value (Rs mn.) 40,560 29,031
Equity value per share (Rs) 54.08 38.71
(iii) Revaluation of assets (Rs mn.)
Tangible fixed assets 6,500
Patents 0
Net current assets 4500
Total assets 11,000
Less: Long-tem loan 3,000
Equity value 8,000
Equity value per share (Rs) 10.67

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