Valuation

Topic Time (Hrs)
Introduction to Valuation 1
Valuing Assets and Liabilities 1
Equity - Discounted Cash Flow 2
Equity - CAPM, Fama French Model and WACC 1
Equity - Dividend Discount Model 1
Equity - Relative Valuation Models 1
IPO Valuation - tips and tricks 1
M&A valuation and Net Assets value 2
Debt Valuation - techniques 1
Preference Share - overview 1
Derivatives - Introduction 1
Conclusion 1
14
Introduction To Valuation
x What is Valuation?
x Why is Valuation required?
x Who is allowed to do valuation?
x What do you value?
x Real Life Applications of Valuation
What is Valuation?
Look up Ashwath Damodaran!
Valuation is a quantitative process of determining the fait value of an asset ot liability.
Valuation is very subjective - which means there are a lot of assumptions baked into the philosop
Imagine you have a house in South Delhi - in one of the posh areas.
If I saw the house from Bangalore - I would say the house is valued at a minimum of 1 cr.
But if a real estate valuer comes to your house, values your land and assess the neighborhood,
Real estate valuer has a more expert opinion on the value of the house.
But I, in BLR, have a more fabled opinion.
But if I ask you, Mr X - or I ask Ishaan - minimum 5 cr
Value is always subjective - it differs by the person!
DDLJ - everyone has seen it? The movie!

This movie is still running in a theater in Mumbai - this movie is also available for free in Amazon p
Or Netflix.
Pirated copy (illegal) - FREE
Why would someone pay 350/- for a movie if the same film is available for free?
The experience - there is an intangible value associated with watching it in theater.
The value of an asset = subject + intangible
But as valuation experts - as people who are going to learn valuation - I am not going to worry ab
What can be put on paper, what can be estimated. What can be evaluated, what can be quantifie
For me, DDLJ in OTT > DDLJ in theater. Same product.

For me, South Delhi house = the best price it will fetch if I sell it. All emotions can go to hell!
Same product will have multiple valuation techniques - which will give multiple values. What will yo
I will teach you every technique - I will tell you how this can be used!
For eg - tell me what are the different ways you can get a value for the house you stay in (3 diffe
Simplest Way Ask your neighbor!

Complex Way Ask an expert!
Most Complex Way Find out about economy, how much inflation, cost of construction, how much p
All three values will probably give you the right number. Because - if someone is buyng the house
They will also check with an expert, and the expert will also use the formula you used in point 3.
THE END
x Why is Valuation required?
Price =/ Value
Price as a concept is different, and value as a concept is different.

We need to know the value of a product, and only then can we decide whether to buy that product or not.
The price of the product is on the sticker.

But the value will never be mentioned - we need to find that out!
And once we know the value we need to know whether the price of the product is less than or greater than the value.
For EG - we go to a grocery story! We ask for a soap.

The storekeeper gives us two soaps -
Dove 50 MRP
Cinthol 15 MRP
What is the value of a product? Is the Dove soap really worth 50, or is it just intangibles.
How will you find out the value of soap?
Does it kill all germs?
Does it remove odour.
Does it cause any skin reaction
Does it cause dry skin/ oily skin
Are there any chemicals?
Once we check all this, we will see that Dove probably has more value than Cinthol - but does Dove have 3x value?
Therefore, I will go with Dove - else, go with Cinthol.
Another example - Nivia - sells its shoes at 400/

Adidas sells their shoes at 4000/
What is the extra value that Adidas brings to the table?
does it last longer?
is it lighter?
is it more comfortable?
Investment decision - whenever you buys a share or bond in the market, you need to know whether you are overpaying o
You need to first find out the value of the share or bond you are buying, and then figure out what price it is being sold and
Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
RELIANCE (REL 346.46 394.56 983.97 485.42 570.44 166.28 544.07 204.73 108.51 85.70
Decision BUY BUY DON’T BUYDON’T BUYDON’T BUYBUY DON’T BUYBUY BUY BUY
Tell me if you will buy REL or NOT
100
0.00
750.
00
500.
00
250.
00
0.00
J…
J…
J…
J…
J…
J…
J…
J…
J…
J…
VALUE 425
Anything above this value, REL is overvalued, anything below, REL is undervalued.
Undervalued - it means it is coming cheap - > BUY
Overvalue - it means it is expensive - > DON’T BUY, SELL
x Who is allowed to do valuation?
Anybody who knows the concepts really well, and who is technically strong.
Technically strong - depends on the kind of product that is being valued!
But there is no licensing required, no proof required that you know something etc.
x What do you value?
ANYTHINGGGGGG@@@@@
Weather - there are weather derivatives in the market and these are being valued/ priced!
Shares
Bonds
Derivatives
consumer products
real estate
time valuation!
But what we will cover as part of our lessons in finance is only basic valuation for financial products.
x Real Life Applications of Valuation
When you are applying for an IPO - is the IPO price undervalued or ovevalued?
When you are buying shares from the market - is it undervalued or overvalued.
Merger arbitrage - whether the target/ acquiring companies are under/ over valued.
THE END
Valuing Assets and Liabilities
x Different types of assets and liabilities

x How do we value the different types of assets and liabilities?
x Time Value of Money - some examples
x Future Value of Money - Basics
x Future Value of Money - Complex
x Present Value of Money - Basics
x Present Value of Money - Complex
x Different types of assets and liabilities
Companies that are in service industries - will have very less fixed assets.
Companies that in manufacturing industries - will have greater amount of fixed assets.
Capital and Liabilities (REL) Price/ BS Value
Capital
Equity Share Capital 1,200 Will be the present value of Assets - Liab / Divident Growth
Preference Share Capital 950 Will be Divident Growth
Liabilities
Long Term Liabilities
Sundry Creditors > 1 year 15,000 estimated value of how much you can pay / wil pay!
Payables > 1 year 8,000 estimated value of how much you can pay / wil pay!
Debentures/ Bonds Issued 1,200 Fair Value/ Present Value of bonds/ liabilities
Loans Repayable 1,000 estimated value of how much you can pay / wil pay!
Short Term Liabilities

Sundry Creditors <1 year 28,000 estimated value of how much you can pay / wil pay!
Payables < 1 year 6,000 estimated value of how much you can pay / wil pay!
Assets
Long Term Assets
Fixed Assets 20,000 What is the PV of utility from these assets?
Intangible Assets 5,000 What is the PV of utility from these assets?
Investments 2,000 Eq - you will value using DDV, etc. If Bonds - DCF etc.
Current Assets
Cash 1,000 Price = Value, unless the bank is YES Bank!
Sundry Debtors 50,000 estimated value of how much you expect to receive.
Prepaid Expenses 5,500 estimated value of how much utility you plan to derive from these services.
THE END
x How do we value the different types of assets and liabilities?
Sundry Creditors!
Who? These are people we owe money to! We owe them money because there are different services/ goods/ supplies that
Why? We owe them money because we received services/ products from them! And we need to pay them back!
How? This is the value of the services or products received. Generally - this is the price of the service or product minus any
If we think we wont pay them - only in those cases, the price will not be equal to the value!
Example!
Reliance receives a lot of their upstream steel supplies from TATA Steels.
So who is the creditor? TATA Steels.
This is to be paid back by the end of 2021 - @1000/ kg of steel received minus any trade discounts.
Discounts are at 50/ kg if paid within the calendar year when the actual item was sold!
Price - 1000/ kg
What will be on the BS - 1000/ kg in the BS
What is the value of this item - this is more from a realistic perspective!
If you do not repay within the calendar year, price and value are the same! No discount!
But if you think you will repay within the calendar year, the value is only 950 of amounts payable!
Payables
Who? They are generally the rent payable guys, salary payable employees, wages payables, electricity payable etc.
Why? Because we received a good or service from them?
How? Rent payable is based on the invoice raised! So what you see as price or in the Balance Sheet will be the amount of
This is usually raised in advance!
For ex - you occupy a property on Jan 1, 2021 - you will have to pay them rent in advance and that will be called rent paid
But the concept we are looking at is rent payable! Which is after the invoice is raised! This is the actual amount of payable
This is the value you will see on the Balance Sheet or as Price in our eg.
So what is the value? The value is actually the utility that you derive from it.
So for eg - they will raise an invoice for 30 days, but if you expect to vacate in 15 days - you will only derive a value or get a
Therefore - rent payable in BS =/= the value of rent utility.
Example Reliance is occupying Mr Shah's property for 2L/ year, Mr Shah has raised the invoice for the same! Reliance expects to ut
What is the amount you will see for the below?
Price? 2L
Balance Sheet? 2L
Value? 1.5 L
You walk into a supermarket.

You pick up a coke from the refrigerator, and while waiting in the line, you drink half the coke, and throw out the rest!
You arrive at the billing counter.
How much will you pay for the coke?
That’s the price. 50 You have to pay the entire amount, even though the utility that you
How much utility did you get from the Coke? That’s the value! 25 Because you paid o
One tin = 50
Fixed Assets/ Intangibles
What? These are basically items that we purchased which have use for more than 1 year, therefore we do not charge the e
We charge it over the life of the asset!
Why? This is the cost of the asset approtioned over the life!
How? Lot of techniques, SLM, WDV!
Examples
Reliance purchased a heavy duty machinery for manufacturing boxes, at 10L, 3 years ago. The expected life of the machin
Reliance uses SLM for depreciating.
This machinery is used to make boxes that get Reliance a profit of 3/ box. Every machinery is used to make 1000 boxes pe
Price? 10L - Depreciation (10L/ 10 = 1L/ year) 3L = 7L

B/S? 7L - 1L = 6L
Value? 3,000
All of this - mention for 2021 alone!
Why are we worried about calculating value and price for something?
The answer is that if you have to sell this machinery , and replace with something new, what you are letting go is not just a
You are letting go the potential to earn 3000/ year!
How can we apply this to intangibles?
Examples
Haldirams has a copyright on its brand name worth 10L.
If Haldirams wants to sell the brand to Bikanerwala - it will sell it for 10C!
Amount For whom will this be relevant?
Price? 10L For anybody who is trying to understand a minimum value to pay for Haldirams brand name!
B/S? 10L For Haldirams' shareholdrs.
Value? 10C Is the max value anyone will pay if they are trying to buy Haldirams' brand name!
THE END
Discounted Cash Flows
x Time Value of Money - some examples

x Future Value of Money - Basics
x Future Value of Money - Complex
x Present Value of Money - Basics
x Present Value of Money - Complex
Question! If you had the option of receiving 1L rupees today vs receiving 10K rupees every month for the n
What is the answer?
Some people will say 1L today, why? A bird in hand is better than two in the bush - it basically me
Why?
Because you might not be there in the future, the person who has to pay you might not be there
Some people will say 10k per month is better. Why? Because it is more planned - what if I get 1L
Better to receive it in installments.
If you receive 1L today, you can invest the 1L and after 10 months you will get how much? Assum
1.1L.
Or, you might spend the 1L, in which case you are left with nothing!
Compounding will tell us which is the better option!
Question You want to go to the supermarket and buy Lays chips for 20/-.
The supermarket guy tell you, pay me 40 Rupees today, take one lays chips now……come back
Which is the better option? Better option is to shut up and leave the shop!
Purchasing Power!
Purchasing power is the ability to buy something today by spending cash. This will change over ti
Option AOption B
2021 20 20
2022 20 22
2023 20 24.2
2024 20 26.62
2025 20 29.282
2026 20 32.2102
2027 20 35.43122
2028 20 38.97434
2029 20 42.87177
2030 20 47.15895
2031 20 51.87484
2032 20 57.06233
2033 20 62.76856
2034 20 69.04542
2035 20 75.94996
2036 20 83.54496
2037 20 91.89945
2038 20 101.0894
2039 20 111.1983
2040 20 122.3181
Option B is the correct answer. Why? The purchasing power of any commodity, or the value of mo
1960 A cup of tea cost 1 Rupee

2021 A cup of tea costs 50 rupees.
If in 1960, you kept 1 rupee under your pillow hoping to buy a cup of tea in 2021, you will be very
1960 Avg salary for a graduate was close to 100 rupees

2021 Avg salary for a graduate is close to 20000 rupees
What are we trying to say?
Time value of money is the value of 1 rupee over time!

Money value will change with inflation, growth of the economy and finally standard of living!
For example - you want to buy a mobile phone in 1996! What were the brands available? Nokia! Alcatel! Onl
So if you had a budget, you might have to spend more because whatever price Nokia asks for you need to p
But today, if you look at mobile phones - you can get a good phone for 1,000 or 1L
How many people had cars in 2000? How many people had cars in 1950? How many people have
Money loses its value over time!
So why are we talking about all this? How is this even relevant? Very simple!
If I am valuing soemthing, I need to know how much it is valued at today!!!
Not 10 years down the line.
For example - I hold a zero coupon bond!

A zero coupon bond pays no interest. It will repay your principal and include all your interest paym
For eg - I will pay 9000 when I buy the bond. The issuer will not pay me any interest, but will repay
What does it mean? It means there is an interest component of 1000 in the bond!
2021 I buy a zero coupon bond for 95,000 (5 year bond, no interest, repayable at par!)
2022 No interest
2023 No interest
2024 No interest
2025 No interest
2026 No interest, but principal is repaid at 1,00,000
Which means how much is your inherent interest?
Your inherent interest amount is 1L minus 95K that you paid initially, which is 5K rupees.
But what do I want to do? I am sitting in 2021, hoping to receive 1L in 2026. How do I know the va
We use time value of money calculation.
What do we do?
We bring the value from 2026 to 2021 using a certain % rate.
2021 2022 2023 2024 2025 2026

1L
After doing this, if you notice that the value of 1L today is 98K, but you have to only pay 95K to b
Yes, you will buy it!
Why, you are only paying 95K for a bond that is worth 1L (98K).
Which is good! You are paying less for something that has more value!
Therefore, buy! This is basic common sense!
THE END
Future Value of Money - Basics
What does future value of money mean? It means we are going to try and understand how to predict the future value of cash/ money that we have today!
If I have 10K today, what is the value in real terms of this 10K in 10 years time, 2030?
What value of money in 10 years will equal 10K rupees today?
Question Will you need more money 10 years down the line, or less money to have equivalent of 10,000 rupees today.
I can buy a good refrigerator today with 10K.
If I need to buy a good refrigerator in 2030, will I need more than 10K, or less than 10K?
The answer is I will need more than 10K to buy a good refrigerator in 2030,
Don’t believe me?
How much did you need to buy a car in 1960? Around 1,000 rupees!
How much do you need to buy a car in 2020? You need atleast 5L.
Therefore, as time goes on, you will need more amount of money to buy the same things.
How do you know how much more money!
In order to understand how much more money is required to match the 10K we have today, we make use of a rate!
This rate = rate at which money grows!
You can call it inflation, you can call it government interest (bond rates) etc.
We will discuss this more closely later!
Rate = interest + inflation

Sometimes, we assume interest is 0, and only inflation, and soemtimes its vice versa.
FV = PV x (1 + Rate)^T
PV = what value you have today, in our example it is 10,000

1 + R = multiplicative factor to grow our money
^T = exponential factor, that tells you how many times should you grow your money!
End OF 0 1 2 3 4 5 6 7 8 9 10
10,000 11,000 12,100 13,310 14,641 16,105 17,716 19,487 21,436 23,579 25,937
Assumption: the rate we are looking at is 10%
This means that I need to have 25,937 at the end of 10 years in order to purchase the same things that I am purchasing today for 10,000 Rupees!
Question You have 75,000 in your bank account

You want to invest this in a deposit for 8 years. The deposit gives you a rate of 12% per year!
Tell me what is the expected value of your current bank balance in 8 years if you invest this in the said deposit.
0 1 2 3 4 5 6 7 8
75,000 84,000 94,080 105,370 118,014 132,176 148,037 165,801 185,697
If you deposit 75,000 today, at the end of 8 years you would have 185,697
What will be the valueis 2750 years?
75000 1.12 2,236,466,220,543,910,000
167,734,966,540,793,000,0
Question You have 90,000 rupees today!

You have two investment options!
Option A You can put it in a safe investment like government bonds, no default - very safe will give you 6% return over the next 15 years.
Option B You can put it in a corporate bond, which will give you either 4% return over 15 years or 9% return over 15 years. The probability of both is 50-50.
You need to find out which is the better option for investing - where is your return higher?
Principal Multiplicative Value Exponential M ^F FV

Option A 90,000 1.06 15 2.40 215,690 215,690
Option B
Bad Scenario A 90,000 1.04 15 1.80 162,085 215,690
Good Scenario B 90,000 1.09 15 3.64 327,823
244,954
Therefore, which is the better option?

The better option is the option which gives us a net high return!
And which option is that?
Option B!
What is the risk of option A - the risk is losing return of 29,264 Rupees
Why? Because you went for a safer instrument!
What is the risk of Option B? Th risk is that you will lose 53,605 Rupees
THE END
Present Value of Money
Present value of money basically says, how much money you might get in the future is irrelevant!
How much that is worth today is what is most relevant!
Assume you will get 10,000 rupees today, you are trying to understand whether that is a good idea, or getting 1L after 25 years is a good idea.
How will you go about it?
Assume the current rate of interest in the market is 10%.
You have two options - Option A - get 10K today! And Option B - get 1L after 25 years.
Using the future value concept we saw, can we arrive at a decision?
Imagine, you invest 10K today, and you want to know how much it will be valued at after 25 years.
If that value is > 1L , then go with 10K today. Else. Choose 1L after 25 years.
Today, I am 25 years old and I can get 10K. And I can invest this 10K in the bank, and when I am 50, I will be able to withdraw this amount. How much is that amount?
Is that amount greater than, equal to or less than 1L?
If it greater than 1L, then go for 10K today!
If 1L is greater than that amount, choose 1L after 25 years.
If both are equal, you are indifferent. You don’t have an opinion, anything is OK!
We will try growing this 10K for 25 years by investing it in a bank - P * (1 + R) ^ T = 108,347
if you get 1L after 25 years = 100,000
Therefore, the first option is better, get 10K today!!!!
In this concept, what we did was, we took the 10K to a future period and compared with a future cash flow (1L) and decided which is better!
The other option is to bring the future cash flow (1L] to today's preiod and compare it to what we will get today!
A B
2021 2045
10K 1L
A B
2021 2045
10K 1L
FV = P * (1 + R ) ^T
1L = P * (1.1)^25
1L = P
1.1^25
FV = P
(1 + R)^T
100000
1.1^25
9,230
10,000
10,000 today is better than 1L in 25 years!
Question Mr X wants to invest in a land that he will pay 10L to buy today, and he will get 1.5 CR in 25 years time! Alternatively, Mr X can deposit that money in a savings accou
annually!
Interest from savings accounts are tax exempt in the country where Mr X resides, but real estate gains (capital gains) are taxable at 20%.
Find out which investment option is better - Option A: Land or Option B: Savings Account
Answer Option A What is the value of 1.5C in today's terms -> FV = 15000000 MINUS Tax= 2,842,583 Rupees in today's terms!
(1 + R) ^ T 1.06^25
Cost = 1,000,000
Profits = 1,842,583
Tax = I have topay a tax on the gains I enjoyed on this land

= 1.5C - 10L x 20 % tax
= 2,800,000
Option B What is the value of 10 L today if you invest it in a 6% interest rate account>? = 10 (1 + R) ^ 25
(1 + R) ^ 25
Profits = 1,000,000
Option A is the better investment! Why? It has a better FV today even though there is taxation!
To make this more intuitive, you are growing 10L by greater than 6% under option A, and bringing it back at 6%.
growing = compounding
bringing it back = discounting
Everytime your rate of compounding > discounting = PV go up!

If rate of compounding < discounting = PV will go down!
If rate of compounding = discounting = no change to PV!
THE END
Complexities in Time Value of Money.
The components involved in a time value of money analysis are below -

x Present Value
x Future Value
x Rate of Interest
x Time!
Rate of compounding or discounting - Basically depends on the following

1 Opportunity Cost
2 Rate of Interest In the Market
3 Inflation
Nominal Rate and Real Rate!
Nominal Rate = Real Rate + Inflation
Time - for compounding is basically the number of times you compound dueing the period you compound for!
In our examples, we assumed that we compounded only once a year!
But what if we compount monthly?
What if we compound daily?
Your FV in the future will also increase
But always remember - we need to have a link between T and R!

If T is being done weekly, the rate should be a weekly rate of interest.
The question might give you a yearly rate of interest, and ask you to compound weekly. You need to make sure to convert the yearly
correct answer!
Both your measures should be in the same denomination!
Question Mr X is an American who wants to invest in India. He wants to determine the correct rate to be considered for making his investments.
he is being told that these investments can be made in multiple rates, that is there are different comparebles present in the market. H
which one he is more comfortable to use for his investing purposes.
Simple Interest Rate - 5%

Opportunity Cost - 7%
Inflation - 9%
Nominal Interest Rate - 14%
If you are given the nominal rate - always use the nominal rate in your answers.
So how is the nominal rate being arrived at? Simple Interest Rate + Inflation = 14%
Why don’t we use the opportunity cost? Because Mr X is American, the opportunity cost is the cost of investing in his own country - w
Therefore, opportunity costs don’t matter!
Question Mr X understands that the formula for compounding changes when you compound multiple times in the same year!
Mr X wants to compound weekly, what will T be for Mr X in his formula?
Assume his period of investment is one year!
T =n xt
small t = number of years.
n = number of times you are compounding
T = 54 x 1 = 54
Question Mr X has decided to go ahead with his investment in India, and invests 150,000 in a mutual fund that promises a return of 10% per ye
You need to find out how much will Mr X earn if he stays invested for 3 years.
P = 150K
R = 10% = 10/12 = 0.8333333333
T = n x t = 12 x 3 = 36 36
FV = P x (1 + R) ^ T
= 150K x (1 + 0.0083)^ 36
202,203
What if Mr X did not compound this monthly, but went for a yearly compounding, will the answer remain the same?
P = 150K
R = 10
T=3
FV = P x (1 + R) ^ T
= 150K x (1 + 1)^ 3
199,650
Because of monthly compounding, Mr X actually makes 2,553 more!
Therefore, if you are someone investing in the markets, the more you compound, the better it is for you!
Question Assume after 3 years, Mr X's prediction is accurate. He wants to understand, how much should he have invested in order to make 3L
the question is how much more should he have invested to make this amount - assume same monthly compounding and 3 year tenur
FV = 300K
R = 10% = 10/12 = 0.8333333333
T = n x t = 12 x 3 = 36 36
FV = P x (1 + R) ^ T
3L = P x (1 + 0.0083)^ 36
P = 300K/1.0083^36 222,787
THE END
Discounted Cash Flow
So when you try to make an investment and take a decision based on that, you have to understand how much this investment will be valued at or will be worth in today's terms.
So we need to see how much a particular investment will fetch us in today's terms.
The present value = which is what we need, because our investment will be repaid over multiple years. So you need to pull all your future benefits to todays date.
Let us look at an example - REL wants to purchase a machinery that will give it a benefit of 50K for 10 years.
Cost of the machinery is 3L.
Is it a good purchase or a bad purchase?
Advantages
Easy to understand
Easy to calculate
Will give you an approximation really quick.
Disadvantage
This method requires a lot of assumptions to be made!
Formula for discounted cashflows = All investments minus all benefits brought to the present.
It means you need to find out the present value for all the investments and benefits that are there out in the world
If the present value of benefits > present vaue of investments -> go for the investment, it is good.
If the present value of benefits < present value of investment -> don’t go for the investment, it is bad!
Question You are asked to invest 3L in a machinery, which will give you a benefit of 50K per year for 10 years, determine if this is a good investment or not!
Discount rate - 10%
Some basics first!

1 Whenever we say we are making an investment today, assume it is today!!! So no discounting required to bring it to present value, because it is already at present value!
2 Whenever we say there is a benefit that will accrue over ten years, assume the first payment of benefit starts from 1 year down the line - never assume first payment is done
today, since most cases, you will only get the benefit after making the investment -> so, unless specified in a Q, never assume the first benefit payment will be received today!
0 1 2 3 4 5 6 7 8 9 10
Investment -300,000 - - - - - - - - - -
Benefits 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000
Discounting 1 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855
Discounted Numbers -300,000 45,455 41,322 37,566 34,151 31,046 28,224 25,658 23,325 21,205 19,277 7,228
Therefore, the net benefit of making this investment is 7,228 rupees!
Question You are asked to invest 6L in a machinery, which will give you a benefit of 50K for 20 years., determine if this is a good investment or not!
Discount rate - 10%
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Investment -600,000 - - - - - - - - - - - - - - - - - - - -
Benefits 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000
Discounting 1 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486
Discounted Numbers -600,000 45,455 41,322 37,566 34,151 31,046 28,224 25,658 23,325 21,205 19,277 17,525 15,932 14,483 13,167 11,970 10,881 9,892 8,993 8,175 7,432 -174,322
Why is my loss so big when I doubled investments, but at the same time, I doubled my benefits period?
The answer is simple - the more you invest in the beginning, the more you will have to get as benefit within the same period of the initial investment.
But if you keep the benefit amount as the same, and only increase your duration of getting the benefit, it is riskier.
What if I double my benefits, instead of increasing the duration?
Original
0 1 2 3 4 5 6 7 8 9 10
Investment -300,000 - - - - - - - - - -
Benefits 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000
Discounting 1 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855
If I double Duration and investment, but benefits are the same
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Investment -600,000 - - - - - - - - - - - - - - - - - - - -
Benefits 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000
Discounting 1 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855 0.3505 0.3186 0.2897 0.2633 0.2394 0.2176 0.1978 0.1799 0.1635 0.1486
Discounted Numbers -600,000 45,455 41,322 37,566 34,151 31,046 28,224 25,658 23,325 21,205 19,277 17,525 15,932 14,483 13,167 11,970 10,881 9,892 8,993 8,175 7,432
If I double investment and benefits, but keep duration the same
0 1 2 3 4 5 6 7 8 9 10
Investment -600,000 - - - - - - - - - -
Benefits 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000
Discounting 1 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 0.5132 0.4665 0.4241 0.3855
My profit is doubling!
Original Profit 7,228

My 2x Investment, 2x profit 14,457
2.00
This means that if the duration of your investment is the same, and you only double the investment amount and benefits you will get from it, your profits today are also double!
The key here is to keep your duration to only 10 years!
THE END
Question A firm gets the below cash flows over the next 10 years. Analyse and understand where the firm is profitable or not.
Investment Today (2021) 2,500,000

Benefits 2022 500,000
Benefits 2023 500,000
Benefits 2024 500,000
Benefits 2025 500,000
Investment 2026 350,000
Benefits 2027 200,000
Benefits 2028 200,000
Benefits 2029 200,000
Benefits 2030 200,000
Assume a cost of capital of 8%, and analyse whether the firm is profitable or not.
Discount at Cost of Capital
Answer 1 Today (2021) -2,500,000 1 -2,500,000
2 2022 500,000 0.9259259259 462,963
3 2023 500,000 0.8573388203 428,669
4 2024 500,000 0.793832241 396,916
5 2025 500,000 0.7350298528 367,515
6 2026 -350,000 0.680583197 -238,204
7 2027 200,000 0.6301696269 126,034
8 2028 200,000 0.5834903953 116,698
9 2029 200,000 0.5402688845 108,054
10 2030 200,000 0.5002489671 100,050
-631,305
Since the total value for the firm is in negatives, the firm is actually losing money! Therefore, this is not a good investm
This or That Decisions

Basically, this or that decisions involve analyzing the discounted cash flows for a particular company, between two options.
Based on which option has the better discounted cash flow, we will go ahead and choose that option! This will ensure that you derive the best possible valu
So for example, Mr Ambani can choose to open a hotel in two places - either in Chennai, which is more of a temple tourism city, or in Mumbai, which is more
Based on that, you need to analyze which option is the better option, and which one he needs to go with
So let us look at the cost - benefit analysis for the two options!
Chennai Mumbai
Investment 6,000,000 9,000,000
Benefits for the next 25 years 500,000 750,000
Maintenance costs for the hotel/ yr 125,000 200,000
Salary Costs/ yr 90,000 100,000
Rent cost 65,000 75,000
For both the options, Mr Ambani has to take a loan from Citibank @ 11% rate of interest. Find out which option is more profitable, and analyze whyyyy this o
Answer Chennai Mumbai

Investment -6,000,000 -9,000,000
Benefits for the next 25 years 500,000 750,000
Maintenance costs for the hotel/ yr 125,000 200,000
Salary Costs/ yr 90,000 100,000
Rent cost 65,000 75,000
220,000 375,000
Chennai Mumbai Chennai Mumbai
1 220,000 800,000 198,198 720,721 90.090%
2 220,000 960,000 178,557 779,158 81.162%
3 220,000 1,152,000 160,862 842,332 73.119%
4 220,000 1,382,400 144,921 910,630 65.873%
5 220,000 1,658,880 130,559 984,465 59.345%
6 220,000 1,990,656 117,621 1,064,286 53.464%
7 220,000 2,388,787 105,965 1,150,579 48.166%
8 220,000 2,866,545 95,464 1,243,870 43.393%
9 220,000 3,439,854 86,003 1,344,724 39.092%
10 220,000 4,127,824 77,481 1,453,756 35.218%
11 220,000 4,953,389 69,802 1,571,628 31.728%
12 220,000 5,944,067 62,885 1,699,057 28.584%
13 220,000 7,132,880 56,653 1,836,818 25.751%
14 220,000 8,559,456 51,039 1,985,750 23.199%
15 220,000 10,271,348 45,981 2,146,756 20.900%
16 220,000 12,325,617 41,424 2,320,818 18.829%
17 220,000 14,790,741 37,319 2,508,992 16.963%
18 220,000 17,748,889 33,621 2,712,424 15.282%
19 220,000 21,298,667 30,289 2,932,350 13.768%
20 220,000 25,558,400 27,287 3,170,108 12.403%
21 220,000 30,670,080 24,583 3,427,144 11.174%
22 220,000 36,804,096 22,147 3,705,021 10.067%
23 220,000 44,164,915 19,952 4,005,428 9.069%
24 220,000 52,997,898 17,975 4,330,192 8.170%
25 220,000 63,597,478 16,194 4,681,289 7.361%
1,852,784 53,528,293
Investment -6,000,000 -9,000,000
-4,147,216 44,528,293
Both projects are not profitable, but if you have to choose one of these projects, choose the one with the least loss - C
Analysis
1 Why is our project for Mumbai profitable without discounting, but not profitable after discounting?
2 At what discount rate will Mumbai break even?
3 Is there an issue with our assumptions or our calculations? Are we doing something wrong?
Let us assume 10% inflation
As long as our inflation< discount rate - we will be making losses. If inflation > discount rate, we will make profits.
THE END
CAPM, FF and WACC
Capital Asset Pricing Model! - this is majoly used for equities
It gives you a relationship between the expected price of the equity we have, the risk free rate, BE
Expected Price of the equity is a function of risk free rate, beta and risk premium.
Expected Price E = RF + B(RP)
We are going to find out what E is.
RF = given in the question, this will be the minimum rate fixed by the Central Bank of the country.
B = sensitivity of the security to the market
If the security moves by 1 Re for every 1 Re move of the general market (index), then we say B =
Market = the general stock market. A good substitute / indicator is an index in the market.
RP = MRP or Market Risk Primuum or RP = M Return minus RF Return
The stock that we are analyzing is INFY.

Now, INFY has a price in the market of 350 Rs/ stock.
We need to calculate INFY's real price based on CAPM and decide if INFY is a BUY or SELL.
RFR = 6%
SENSEX = 9%
For very 1% move in SENSEX, INFY moves by 1.5%
What is INFY's BETA? 1.5/1 = 1.5
ER = RFR + B (RP)
ER = 6 + 1.5(9-6)
ER = 6 + 1.5*3
ER = 6 + 4.5
ER = 10.5%
It means if you buy INFY today, you should be expecting a return of 10.5% annualized.
But…. Will this always be the case?

There is a chance INFY gives less return, gives more return etc.
If INFY adheres to CAPM - understand what its price one year down the line could be - 350 + 10.5
386.75
Question Assume you are now valuing BOB - and you have to find out the expected return for this stock.
Same Risk Free Rate and Sensex performance as the last question. But BOB falls by 1% for eve
RFR 6%
RP 3%
Beta -1 It has something called as a perferct negative correlation with the market
Which means everytime the market moves in a particular direction, the stock w
Is there any benefit of owning a stock which is always negatively correlated. T

market goes up?
it moves in the opposite direction of the market! Therefore, if you expect a sto
market will go down!
ER 3 3%
Now in the next year, the stock is still in our portfolio, but this time, the market has crashed by 10%
RP -16
ER 22 22%
The expected return from stocks is basically how much a shareholder will expect from the equity f
There is an obligation from the company to deliver this to the shareholder (this is according to the
This 'delivering of return' to the shareholder is done in two ways

1 Better performance by the company -> better share prices -> happy sharehol
2 Better performance by the company -> dividends
Technically, this CAPM ER that we calculated is a cost to the company - and is called the cost of r
If the company makes 8%, the company has failed!

If the company makes 12%, the company has succeeded, but the first 10% is taken away by the e
THE END
CAPM has a fancy terminology asociated in it called the Beta!
Beta is nothing but the sensitivity of the stock, to the index.
Beta can be any value - +INF to - INF
Positive Beta - means the stock is rising when the market rises, and the stock is falling when the ma
Negative Beta - means that the stock is going in the opposite direction to the market.
Zero Beta? It means that the stock never moves irrespective of what happens in the market.
How is Beta Calculated = Covariance between the stock and the market
Variance of the Market
MARKET = A representation of the market - index, SENSEX, NIFTY, NASDAQ, NIKKEI, DAX, FTSE e
A concept - Beta!
Beta is basically a concept of risk.
There are two types of risk for every stock! The general risks of the market, and the specific stock r
You want to invest in a company called IOCL.

They buy crude oil, refine it and sell in the market as petroleum.
General Risks - crude oil prices, tension in the Middle East, electric vehicles, natural resource depl
Specific Risks - key person risks, financial statemtn risks, reputation risks. Etc
General risks - systematic risks.

Specific risks - non systematic risks
Now, as an investor, it is your duty to get rid of all systematic risks.

How do you get rid of systematic risks?
By diversification.
If you buy 1 share in IOCL - also buy the below shares -

1 share in TESLA
1 share in BP
1 share in Exxon
By following the above portfolio - you have gotten rid of all systematic risks.
It is the duty of all investors to get rid of all systematic risks in their portfolio!
Higher the risk, higher the return!
Higher the unsystematic risk, higher the return! You will not get any reward for holding on to system
The only risk you will be exposed to is unsystematic risk!
And it is only basis this unsystematic risk that we will actually find out expected return.
Therefore, Beta is also called the unsystematic risk of a company!
Imagine you are doing your CFA Level 1.

You know there are 10 chapters/ subjects you need to study!
There will be questions from all 10 subjects.
If you leave out one subject, and study remaining 9 you are exposing yourself to systemaic risk.
But if you leave out on sub division in a chapter and study the rest properly, you are exposing yours
Leverage!
Leverage is the amount of debt you have in your company!
Two or more companies will have different amounts of debt and therefore will have different leverag
Beta = Asset Beta
Debt beta
Equity Beta = Asset Beta

Debt beta
Equity Beta - is what we use in the CAPM calculations.
You might not have the equity beta for your company!
So you might have to use a comparible equity beta number for your analysis
When we say comparible - we are referring only to our assets.

The assets are comparable!
But is debt comparable? NO!
In order to get your company's equity beta from a comparible equity beta,
1 Unlever the comparible equity beta, so you are left with the asset beta for the
2 We know that the asset beta for the comparible = asset beta for our company
3 Re-level the asset beta using our debt numbers
4 so now you have the equity beta for our company!
Suppose I am trying to find out the Eq Beta for INFY. There is no Eq Beta for INFY available in the m
the Eq B for INFY from WIPRO's Eq B.
1 Unlever Wipro's EQ B, so you are left with the A Beta for Wipro.
2 Now you have WIPRO A Beta = INFY A Beta
3 Re lever INFY's A Beta , so now you have INFY's DEBT Component added
4 INFY's Eq B
You can next use this Eq B from INFY into our INFY's CAPM calculation.
THE END
What is the the WACC or Weighted Avg Cost of Capital?
A cost is nothing but the amount you pay to get something…

The cost o fwashing machine - is how much you pay to get the washing machine
The cost of a TV - is how much you pay to get the TV, so on and so forth.
Now…. What is the cost of an IPO?

That, I am not asking you what expenses are incurred by raising money in the share market.
Are there any dividends promised for equity shares? NO!
Do you promise results, you give them an expectation of results, but you never promise returns, you never promise cap
How do you calculate/ quantify the cost of equity?

We need to think about how much the sharehold expects to receive from the market!
Where have we seen shareholder expectations before? CAPM!

So using the CAPM formula, we can arrive at a shareholder expectation, which the company should try to meet!
Therefore, the ER in CAPM is our cost of equity!
What are the other forms of capital? We just saw equity, can you think of how else capital can be raised?
What do you mean by capital, it is nothing but the raising of money (either with a promise of payment or with no promise
promise of participation.
Participation
Yes No
Promis
ed Yes Prefence Share Debt
Return No Equities unsecured creditor
We saw how equities are classified and valued!

We use a method called CAPM!
Debt
Debt is basically everything that involves a fixed repayment and no participation!
1 Bonds
2 Debentures
3 Loans
These are all having an inherent cost - what is the cost? The cost of interest payment!
So you have to pay interest for this debt! That is the cost for the company!
But there is a small benefit that the company gets because of this debt!
What is this benefit? Tax benefits!
Tax - is generally calculated on your net profits after deducting all expenses …. More the expenses, less the net profits a
Interest expenses are included within the scope of expenses for reducing your tax burder.
Therefore, the actual cost of debt =/= I
Actual Cost of Debt = I (1 - T)
Lets assume you have a loan of 1L, with interest payments at 10% (10k/ year). The company has a profit before interes
Calculate the interest that you will pay, the net profit, the net tax liability and the cost of debt.
Interest - 1L x 10% = 10K

Net Profit = 15K minus Interest = 15K - 10K = 5K
Net tax liability - assume tax in calculated at 20% of net profits = 5K x 20% = 1,000
Cost of Debt = i x (1 - T)
0.08
8% is my actual cost of Debt
The actual interest we paid 10%

How much tax did we save by making this interest payment?
Without Interest = 15K x 0.2 = 3,000

With Interest = 1,000
My Tax Saving 2,000
Actual cost of Debt = Interest payment minus any tax saving

Loan amount O/s
8%
Preference Share Capital
They get a fixed rate of Income - the only difference between a bondholder and a preference shareholder is that…..
Bondholders get interest, which is tax deductible.
Preference shareholders get dividends, which are not tax deductible.
Cost of Capital for PS = D
THE END
Application of the cost of capital!
WACC will tell you how much cost the capital has - and this will determine how much return you must get at a m
Because -
It is the capital you raised that is basically being deployed in a lot of projects!
Return from the project you are using the capital for > cost of the capital
Suppose I take a loan for 5% and use it to start a business. My minimum return from the business must be 5%.
WACC = Prop. Of Eq x Cost of Eq + Prop of Debt x Cost of Debt + Prop of Pref x Cost of Pref
Amount Cost Weights WACC
Example Equity 100,000 9% 0.33 3.00%
Pref 100,000 5% 0.33 1.67%
Debt 100,000 6% 0.33 2.00%
Total Cap 300,000 6.67%
What does this mean?

It means the bare minimum return that I need to get out of all of my investment that I make with the 3L is 6.67%
Anything less than that, return the 3L, close shop!
Anything more than that, profits!
Question ABC Industries need to raise 10L of capital in order to invest in a project that will give them a return of 8%.
ABC raises 5L via equities, through a follow-on public offer, assume ABS has a sensitivity of 1.25 to the market
ABC raises 3L via debt, promising to pay 6% interest. Assume tax rate for ABC is 20%.
ABS raises 2L via preference shares paying the same 6%.
Find out the WACC for ABC, and if the project is a good proposal or not!
Cost Amounts Weights WACC New Weights
Answer Cost of Eq = RFR + B x (MR - RFR) = 9 500,000 0.50 4.50
Cost of Debt = D x (1 - T) = 4.8 300,000 0.30 1.44 0.60 2.88
Cost of PS = Dividends Rate = 6 200,000 0.20 1.20 0.40 2.40
1,000,000 7.14 5.28
WACC 7.14
We need to compare WACC to return on the project, and then determine if profitable or not!
Project 8
WACC 7.14
From the outlook, this seems very profitable!
The most important point!
You remember? We spoke about a discount rate for discounted cash flows?
The best discount rate you can use for your DCF calc is the WACC!
But be selective when you use the WACC - if the company is using only equities to fund a project, do not use th
You should be compare like for like!
For example, in our previous question, assume the company wanted only 5L for the project and they use only t
Same return 8%
WACC 7.14
It is wrong!
Because the debt and PS were not used to fund the project…. You have to use only the comp
WACC 9
We will say that the project is not profitable!
Assume the project is only giving a return of 7%, and only needs 5L for funding it. The company decides to fun
Determine if the project is profitable or not!
Return on the project that we expect 7%

WACC
A 7.14 Total WACC - No! Therefore, this is wrong!
B 9 CoE - Are you using only equity? NO!
C 2.64 Weights under the old WACC x Cost - because you are using old weigh
D New weights have to be ascertained
The answer is 5.28%

Is this higher or lower than what we have?
This is lower.
Cost < Return!
Therefore, the project is a good proposition! We should go ahead with funding the project!
THE END
Fama French Model
Two blokes - Fama and French discovered this model, and this is basically and asset pricing model. We saw another asse
An extention of the CAPM, or the capital asset pricing model!
CAPM = RFR + B x (MR - RFR)
FF = RFR + B1 x (MR - RFR) + B2 x (SC - LC) + B3 x (VS - GS) + E
Three factor fama french model!
RFR = Risk Free Rate (Same as CAPM)

B1 = Sensitivity to Market (Same as CAPM)
B2 = Sensitivity to SC stocks
SC = Index of SC stocks
LC = Index of LC stocks
B3 = Sensitivity to value Stocks
VS = Index of Value Stocks
GS = Index of growth stocks
If the red portion of your formula is +, it means Market is doing better than RFR, and we have +ve correlation to the marke
OR
It means the market is doing badly, that is MR < RFR, and we have negative correlation to the market.
If the green portion of your formula is +, it means small cap stocks are doing better than large cap stocks, and you have a
OR
it means SC stocks are doing worse than LC stocks, SC<LC, but you have a negative correlation to small cap stocks.
If the brown portion of your formula is +, it means value stocks are doing better than growth stocks, and you have a +ve co
OR
It means value stocks are doing worse than growth stocks, VS< GS and you have a negative correlation to value stocks.
Application of the Fama French Model in Real Life
Market Move Long (Buy) Short (Sell) Beta

Increase in RFR RFR MR Negative
Increase in Market Returns MR RFR Positive
Increase in small cap returns SC LC Positive
Crash in small cap returns SC Negative
Crash in Large cap returns SC LC Positive FF = RFR + B1 x (MR - RFR)
Increase in large cap returns LC Negative
Increase in value stocks VS Positive
Crash in value stocks VS Negative
Crash in growth stock GS Positive
Increase in growth stocks GS Negative
Question XR is a long only investor who wants to position a trade in the NIFTY based on NIFTY returns. XR expects NIFTY to crash i
using a FF model.
What will you do?
Answer XR is long only - so no chance of shorting.

If NIFTY crashes, the value in the bracket will be negative - therefore yo need to have a negative B1 to counter it and mak
How do you have a negative B1?
Buy stocks that are negatively correlated to the NIFTY, stocks which will go down if NIFTY goes up!
Question ABC Incorporated are looking to invest in the stock market, and are particularly focussed only small cap stocks. Their inde
Even though they expect the index to go up vs the NIFTY 50, which is the large cap index, they want a position in individua
What would you advise?
Answer Inside the bracket, the index is moving up vs the large cap index, which means there is a +ve effect. Therefore, it makes se
If you need a positive beta, you should be heavily correlated to the small cap stocks.
THE END
Dividend Discount Model
This model basically arrives at the value of equity by using the discounted cash flow model.
Discounted cash flow - basically said - the value of anything that you own today, is the present valu
So, the present value of the cash flows that you get from a particular stock is called the intrinsic val
If the MV > Intrinsic Value, don’t buy, sell!

If the MV< Intrinsic Value, buy!
Using the dividend discount model - we will arrive at the instrinsic value, and then decide whether to
Under the discounted cash flow model - the main cash flow for equities -> dividend!
We discount the dividends to the present value to arrive at the Intrinsic value!
This method is also called the Gordon Growth model!
Value Today = Future Dividends

Rate of Discounting - Growth
Ideally, what you should be having as denominator should be the discount rate for the period!
Dividend 1 = X
1.1^1
Dividend 2 = X
1.1^2
etc. etc. etc.

The main assumption under the Gordon Growth Model is called as perpetuity - meaning, we will hol
Perpetuity = Cash Flow

Rate
This is a simple idea, or a simple expression, but what if the rate increases over time?
It means your present value should also be higher!
So, you will reduce the growth from the rate of discounting.
Example We own stocks of INFY - and expect to get 1000/- per year for the rest of our life. Our expectation (

= 1000
0.1
= 10,000
Assume you think the value will increase by 2% every year!
= 1000
.1-.02
= 12,500
Major assumptions -
1 Growth rate can never be more than discount rate!
Assume that your dividend is growing at 15%

= 1000
10% - 15%
= -20,000
Question You have shares of REL currently trading at 15000/ share. You expect REL to give out a dividend o
The cost of equity for REL is determined to be 13%.
Find out the instrinsic value of REL shares, and if REL is a buy/ sell according to Gordon Growth M
Answer Value Today = Future Dividends

= 1450
13% - 3%
= 14500
The intrinsic value of one share in REL is 14,500 while the MV is 15,000! What does this mean? Th
The other types of calculation under the Gordon Growth Model -

1 One Period Model
2 Multiperiod Model
Till now, we saw perpetual model…. Dividends will be paid forever.
1 One Period Model tells you, you will receive dividends for one period alone and then you
V =PV of D + PV of Selling Price
Example XYZ Corp is currently paying a dividend of 2000/ share.

Mr A has 1 share and expects to sell this in one years after receiving the dividend
Expected selling price - 4500 Rs. Assume 10% discount rate!
V = 2000 + 4500
1.1^1 1.1^1
= 1818.181 + 4090.909
= 5,909
Assume the share is selling in the market for 5000 - will you buy or not? BUY!
2 Multiperiod model - these are genetally more complicated to calculate, since the
But realistically, multi period models are the most practical way of doing DD calc
THE END
Relative Valuation Models
The models we saw till now - CAPM, FAMA FRENCH and Dividend Discount are all standalone models!
When we say these are standalone models, what we mean is that these models only look at the fundamen
CAPM - Beta!
Fama French, 3 Betas!
Dividend Discount - Dividends, and the discount rates!
All of the above pertain ONLY to the stock that we are valuing!
But that changes, when we see something called as Relative Value Models!
Single Valuation Models - fundamentals of the stocks vs the price of the stock!
Relative Value Models - fundamentals of the stocks vs other stocks in our portfolio!
When I say other stocks in the portfolio, I mean other stocks in the industry, the industry avg, etc.
There are broadly two types of valuation multiples!
1 Equity Multiple!
2 Enterprise Multiples, or Enterprise Value Multiples!
Equity Multiples!
These are basically used by retail investors!

Who is a retail investor? Anybody investing for a few shares, or anybody investing for a minority interest!
Minority Interest - if you own less than a particular % of shares, you don’t really control the company!
When you don’t control the company, you must value the shares as if you want to sell them at any time.
Types of Equity Multiples -

1 P/E Ratio
2 Price/ Book Ratio
3 Dividend Yield
4 Price/ Sales Ratio
P/E Ratio = Price Price = Market Price

Earnings!
EPS = Total Earnings/ Total No. of Shares
Earnings also called as EPS.
Through the PE ratio, we are trying to understand what the Price of the Share is, for every rupe
If every rupee of earning is a rupee of price it should technically be 1.

But that is not generally the case!
A PE of 10 means the Market is 10x the earnings of the company!
If EPS is 5, MP = 50
If EPS is 7, MP = 70
Ideally, for a PE ratio, we compare the Market Price of the equity and earnings, with the competitors and i
Small exercise…
PE Industry Avg is EPS MP
INFY 31.28 43.65 1,365
WIPRO 22.54 33.3 18.53 418
32.14 14 450
That means, on an average, all tech stocks have a PE of 33.3.
If you use relative valuation, your INFY is correctly valued, while WIPRO is undervalued
If PE < Sector avg, it means your market price can increase till it hits the sector avg.
WIPRO can go up to 600 without becoming overvalued. In other words, if I have to reword this, W
For any relative valuation, there are two components - numerator and the denominator
We assumed that the denominator would be the same over time. Is this the case?
Technically, the denominator is OLD!
BE VERY VERY VERY CAREFUL, your analysis can go for a toss if denominator changes.
P/B Ratio Price/ Book Value
Numerator is the same as PE ratio, but denominator is different.
Book Value = Fair Value of Assets - Liab

No. of shares.
Quarterly Daily
PB Industry Avg is Book Value MP
INFY 8.84 154.59 1,367
WIPRO 4.13 6.5 101.23 418
It means, INFY is overvalued, and WIPRO is undervalued!
SELL INFY
BUY WIPRO
THE END
Dividend Yield
This ratio is majorly useful for investors who are interested in dividends!
A company with high dividends necessarily does not mean it has good profits, or lets say good fu
Once a company gets a net profit - they have two options, they can either
1 give this proft back to the shareholders - dividend
2 reinvest this profit back into the company - no dividend.
Advantage of dividend - it will attract shareholders who want steady stream of income!
Disadvantage - will not have any reinvestment opportunities. Excess profits due to new products,
Advantage of reinvestment - TESLA, APPL etc. which reinvest and don’t pay a dividend - better p
Disadvantage - not attractive to people who want a steady stream of income!
Further reading if you are interested - Modigliani & Miller.
Dividend Yield = Dividend Per Share

Market Value Per Share
= 1.5 = 50%
3
DY
INFY 1.60%
Sector 1.98%
What does this mean?

1 It means INFY doesn’t pay as much dividends as the industry.
2 It means INFY is reinvesting more money and not paying dividends.
3 It means INFY share price will grow more than the avg industry share
Price/ Sales Ratio
P/S = Market Price Per Share

Sales Per Share
Market Price Share = Market Price that the share is trending on that particular d
Sales Per Share = Total Sales

Total Number of Shares.
Assume a company is able to sell 10 Rs per share. Then technically, the value of the sh
But the share is selling for 45Rs, which means for every rupee of sale, the market is exp
1 It is possible that the sale per share will grow to 45.

2 It is possible that the MV per share will crash to 10.
Enterprise Value Multiples
Enterprise Value = Total Market Value of Shares + Market Value of Debt - Cash
Enterprise Value = It should you how much EV is generated per rupee of revenue/ sale
Revenue
Enterprise Value = Before considering Interest, Tax, Dep, Amortization and (rental).
EBITDA/R
Enterprise Value = Majorly used for capital intensive industries

Invested Capital
where can we use these multiples?
1 If you are confused between how much to invest and which companies to invest in, then
2 M&A - we will see this in more details later, for M&A strategies.
3 Compare divisions!
THE END
IPO Valuation
What is an IPO?
Initial Public Offer!
1 What kind of companies actually do IPOs?

2 Why would you go for an IPO?
3 Who values an IPO?
4 What is minimum subscription, allotment etc?
5 What is underwriting?
6 What is underpricing of an IPO?
What kind of companies actually do IPOs?
It is called an initial public offer - which means this is mainly for companies which have not gone p
If a company is already public, and is raising extra money by issuing shares, it is not called an IPO
It is called an FPO, or Follow On Public Offer, or Further Public Offer.
These companies have to approach SEBI and stock exchanges for launching their IPO.
Companies have to fulfil basic requirements - minimum profits, good reputation, etc.
If SEBI is happy that basic requirements are fulfilled, they will OK the IPO.
Why would you go for an IPO?
Imagine you started up, you put 10K of your own money, and want to make your business huge.
Its been 10 years, the 10K has now become 1 cr. Your company has become famous, and you wa
How do you make the 1cr worth company = 1 cr in your bank?
Monetization!
Exit Strategy for investors - basically, how do you get out of the investment.
Selling the shares to the public - how do you sell shares? Through an IPO.
A. Exit Strategy
B. Grow the business further - how?
You will raise extra cash by IPO, and use that cash to expand the business.
Who values an IPO?
When companies raise cash through an IPO, they will need to specify the price at which the IPO s
This price is usually a band, that is, there is a minimum to max price and the epople can quote wh
For eg - DMART 250-350
Investors can quote any value between 250 and 350 for the IPO. Companies will generally give p
How is this band arrived at?
It is arrived at by a process of valuation - by merchant bankers.
It is very very important that the correct band is arrived at.
If the valuation/ price for IPO is too high, nobody will buy - IPO will become a failure.
If the valuation/ price for IPO is too low, then company will lose money - this is called an underpric
What is minimum subscription, allotment etc?
Minimum subscription - the minimum amount of shares that will have to be subscribed for the IPO
In India, minimum subscription is 90%.
If minimum subscription is not achieved, IPO is a failure.
If minimum subscription is achieved, the next stage is allotment.
Under allotment, the company will try to make maximum profits possible.
So they will allot to the highest bidders first, then to the next highest etc.
What happens if there is more subscription than shares on offer?

This is called oversubscription - pro rata allotment / lottery system.
Question A company wants to issue 10K shares at 800 - 1000 bandwidth. Min sub = 90%. If you owned the
Scenario 1
Shares Amount
8000 950
500 975
1000 775
How will you allot?
But how many were received within the bad? That is only accepted subscriptions.
8500 within the bandwidth
9000 Minimum subscription
Did we achieve minimum subscription? NO!

Therefore, IPO is a failure, no allotment.
THE END
Scenario 2
ABC Ltd wants to issue 2000 shares to the public at 10000-12000 price!
Shares Value
800 12000 800
600 11850 600
800 11500
2200 1400
How much was offered to the public? 2,000

What is your minimum subscription? 1,800
How many subscriptions did we receive? 2,200
So we received more than minimum subscription.
Out of the 800 shares that were subscribed to at 11,500 - I need to choose 600 shares.
The method of choosing is called as pro rating - or lottery.
This is called an oversubscription!
Lottery' system is random, you will randomly choose 600 share application.
But, pro rating is a little more scientific!
You need to select 600/800 shares, which is basically 75%. 75%

So, you will approve the allocation of 75% of every subscription received.
Mr A 100 75 Remaining 25 is rejected!

Mr B 300 225
Mrs C 150 112.5
Mrs D 250 187.5
800 600
What is underwriting?
Underwriting is basically an insurance policy!
The worst thing that can happen to a company is if they fall below minimum subscription in an IPO.
So what they do is they get into an agreement with the merchant bankers to ask them to subscribe to their IP
This is only if they fall below minimum subscription!
For example, if a company XYZ is going for an IPO and has 50,000 it wants to sell!
How much is the minimum subscription amount? 45000
Assume, the company gets only 42000 applications, and has fallen below minimum subscription!
Now - it needs the merchant bankers help!
The merchant banker will help by subscribing to just enough shares so it hits minimum subscription!
How many shares?
3000 shares will be subscribed to by the merchant banker!
Scenario 3
UYT is a IPO hopeful company! They are currently looking to sell 10000 shares in the market at 50-75 rupee
They are not very confident about getting minimum subscription. So they appoint an underwriter to underwri
Based on the below, how many shares does the underwrites have to buy?
Shares Value
5000 72
2500 69
2000 65
1000 48
10500
1 Undersubscription or oversubscription? Undersubscription

2 Is minimum sub met? Yes!
3 If not, by how much is the deficit? No!
4 How much should the underwrite pay the company to buy the deficit? (In Rupees). No!
What are the shares within the bandwidth? 9500
What is underpricing of an IPO?
IPO valuation is extremely important!

If you overvalue - you might not get minimum subscription!
If you undervalue - you do something called underpricing the IPO.

The company will make a loss because you chose to sell the share at a lower price!
Therefore, when it comes to IPO valuation, striking the right balance is extremely important!
Some methods of IPO valuation -
1 Discounted Cash Flow

2 Asset/ Book Value!
etc…
THE END
Mergers and Acquisition Valuation
What is a merger?
An agreement ---- between two companies ----- to become one company!
Jaguar and Land Rover!
One, is obviously for better branding, better looking companies, more market share.
A 15%
B 45%
AB 60%
Suzuki Motors - India. Maruti, Maruti Suzuki!

What did Suzuki benefit from this merger? New market!
Maruti benefit? Better technology!
Flipkart and Walmart?

Flipkart hadnt made a rupee of profits, when it was acquired by Walmart!
Walmart? Is in the business of retail supermarket, retail selling! Brick and mortar presence!
Flipkart? Gateway to online selling!
Vodafone and Idea?
Vodafone?
Idea?
Fighting the monopoly!

Airtel and Jio!
During mergers, there is a specific clause called a No-Shop clause.

This means the companies are prevented from making further acquisitions.
V 50% 33%
I 50% 33%
A 33%
This is to prevent dilution of sharcapital!
Types of mergers!
Type 1
A Ind
B Ind AB Merged
Type 2
A Ind
B Ind A
Kinds of Mergers
1 Conglomerate - where two companies in unrelated business activities merge together to

Eg - WalT Disney merged with ABC -
2 Congeneric - Is a product extention. Two companies with the same market but different
Eg - Walmart and Flipkart
3 Market Extention - where two companies sell the same products but in different markets
Eg - banks merge - to form a single bank!
4 Horizontal merget - this is between companies that sell products in the same industry! C
Eg - Vodafone and Idea.
5 vertical Merger - is when you buy out/ merge with companies in the same supply chain!
Eg - if a restaurant buys out its raw material suppliers.
Example!
Anheuser-Bush Inbev
Bud Light - Budweiser, etc - are all produced by Anheuser Bush Inev!
The END
Valuation Methodologies for Mergers!
Basically, during a merger, one company buys another. How? By providing shares of the company to the shareholders o
A Buys B
A
When A buys B,
A Acquiring Company
B Acquired Company
A will have its own shareholders - B will have its own shareholders -
A1 B1
A2 B2
A3 B3
A4 B4
A5 B5
How do you buy B?

You basically buy B by buying all the shareholders out!
YOU have to give shareholders of B adequate compensation to convince them to sell the company to A.
Too low - B's shareholders wont sell!

Too High - Merger will fail because they overpaid for the merger!
Cost of a merger = How much is paid to the sharehodlers of the acquired company (B's sharehold
Benefit of a merger?
= Synergy that is created!
Some examples of synergy!
1 If Voda and Idea joined together, and managed to defeat Jio!

Voda and Idea would be able to dictate the prices in the market!
2 If Walmart and Flipkart managed to establish a vibrant retail + online presence!
3 If Jaguar and LR managed to expand luxury driving to the SUV and sedan space!
How is the cost of a merger paid out?
1 Cash payment!
2 Equity shares of the acquiring company!
How do you find out how much to pay? = the value of the company you are buying!
1 Net Assets Method!

2 P/E Ratio
3 EBITDA
4 DCF
5 Revenue Multiple (like P/S)
6 Dividend Yield
etc.. Etc…
1 Net Assets Method
Net Asset Value (NAV) of a company = Fair Value of Assets minus Fair Value of Liabilities
Net Asset Value / Share = Net Asset Value/ Number of Shares O/s
Fair Value of Assets = Value that can be generated from these assets by selling the assets in the market!
Fair Value of Liabilities = Value that you need to pay your liabilities
Example ABC Ltd want to acquire XYZ Ltd which is in the same business and is the same competitor in the market
How much will you be paying the shareholders of XYZ Ltd for selling their shares to ABC Ltd?
Note - If companies are direct competitors of each other, it is not easy to buy one other out!
You must pay a premium in order to acquire the other company!
What is a premium? It is a certain % over and above the value determined by your company!
Balance Sheet of XYZ Ltd
Assets Rs FV
Fixed Assets
Machinery 10L 11L
Buildings 5L 4.5L
Current Assets
Cash 3L 3L
Debtors 5L 4.9L
Bank 2L 2L
Receivable from Others 1L 1L
Total Assets 26L 26.4L
Liabilities
Creditors 4L 4L
Debt Borrowings (Debentures) 8L 9.2L
Total Liabilities 12L 13.2L 13.2 13.2
1 Machinery can be sold at 10% profit, while buildings can only be sold at a 5% loss.
2 Debtors are expected to default by 2%.
3 Debt Borrowings need to be paid with a premium of 15%.
The total premium to be paid to the shareholders of XYZ Lts is 20%.

Number of shareholder = 1L.
50% of the amount paid to SH will be cash, and the rest in Equities of ABC Ltd.
Determine -
1 What is the value of payments? 13.2/ share
2 What is the composition of cash vs equities?
50% in eq 6.6 in equity

50% in cash 6.6 in cash
Merger Arbitrage!
THE END
Debt Valuation!
So when a company wants to raise money, it can raise money in two ways - either as equity, or as debt!
Equity - no fixed commitment, don’t have to worry about interest payments, etc.
Debt - there is a fixed commitment, irrespective of whether you like it or not, whether you make profits or not - you have
You can issue debt in the market, and you can get people to subscribe to debt!
As the general public, you can also subscribe to this debt!

0
For ex - DHFL issued debt at 10% rate. It means that you can get an interest of 10% for this debt
InFY is issuing debt in the market It emans INFY is raising money from the market to finance its
INFY is issuing debt at 101 It means 100 Rs of debt is being issued at 101 Rs.
INFY is issuing debt at 97 It means 100 Rs of Debt is being issued at a discount of 3rs, w
The question - why will you invest in debt or debentures or bonds?
1 Guaranteed returns
2 Debt has a negative correlation with equity…..or very less correlation with equity.
Now, what do you mean by correlation?
Correlation is a measure of sensitivity - it tells us how sensitive debt is to equity.
Now, what happens if there is a strong correlation between debt and equity?
If equity rises, debt will also rise!
Example of correlation in real life…

Imagine you invest in an umbrella business and an ice cream business!
1 During summer, ice cream business does well, and umbrella business bad.
negative correlation!
2 During monsoon, Ice cream business does bad, and umbrella does well.
negative correlation
Imagine you invest in tourist boats and ice creams.
1 Both these businesses will do well during tourist seasons…

2 But what happens during the off season? What happens during times of no tourism?
Both businesses do bad!
Inflation
What happens during times of inflation?

During times of inflation, all values rise!
Any investment you have will suddenly look bad!
Except for the following investments

These are called inflation hedges….hedge means protectors.
1 Commodities
2 Real estate
3 Bonds
Normal Bonds - you purchase the bond for 1000, at 10% interest. You receive payment of 100.
This payment is received in 2019, 2020 and 2050. Same 100 rupees.
Wont help you to beat inflation!
Inflation Linked Bonds - where the principal amount, increases with inflation.
You purchased a bond for 1000, and you get 10% interest. If inflation goes up by 15%, the
So the interest you get will be 172.5
Floatin rate bond - where the principal remain the same - so if you purchased for 1000, this will also
But the coupon rate adjusts itself, from 10% if inflation goes up by 2%, co
P I
Normal No No
Floating No Yes
Inflation Linked Yes Yes
Now what happens in the market?

Imagine Mr A is having three bonds, worth a face value 1000.
FV MV Interest
Normal 1000 1250 10*FV 100 You pay less value for the bond and get less
InfLi 1000 1500 10*FV*Inf 100 You pay more value for the bond and get mo
Float 1000 1400 10+Inf*FV 100 You pay more value for the bond and get mo
End of the day, your net returns will always remain the same!
Question KAI Enterprises has three types of bonds outstanding in the market.
FV
Normal 1000
INFLi 1000
Float 1000
Kai pays a rate of 13% interest on these bonds.

Expected inflation is 3% over the next 10 years. The bonds also have a life of 10 years.
The MV for these bonds are as below -

Normal 1100
InfLi 1500
Float 1350
Calculate and present, how much will the investor pay for these bonds when he purchases them?
How much will the interest amounts be for these bonds for the first 3 years when inflation is 0
How much will the interest amounts be for these bonds for the next 3 years when inflation is 2%
How much will the interest amounts be for these bonds for the last 4 years when inflation is 3%
Calculate how much will the investor receive on these bonds when he redeems them?
1 Normal 1100
InfLi 1500
Float 1350
2 When inflation is 0, there is no adjustment to principal or interest rates possible!
FV Interest Interest Amount MV ROI

Normal 1000 13% 130 1100 12%
INFLi 1000 13% 130 1500 8.67%
Float 1000 13% 130 1350 10%
3 Inflation = 2%

Normal 1000 13% 130 1100 12%
INFLi 1020 13% 132.6 1500 8.84%
Float 1000 15% 150 1350 11%
4 Inflation = 3%

Normal 1000 13% 130 1100 11.82%
INFLi 1030 13% 133.9 1500 8.93%
Float 1000 16% 160 1350 11.85%
5 The investor will receive the final FV on these bonds as of the date of redemption!
FV
Normal 1000
INFLi 1030
Float 1000
Liquidity
What is liquidity?
Liquidity = the ability to buy and sell bonds as and when required!
Bonds are not as liquid as equity!

Why?
INFY = Infosys
It has one equity issue!

But as far as bonds are concerned - this is not as simple!
What basically happens -> your bonds are issued as and when money is required.
So, a company will have more than one bond issue outstanding in the market!
INFY
2011 100 cr 12% It will be more expensive in the market, because everybody wants to buy
2016 75 cr 8%
2020 90 cr 7.50%
usually, the most recent issue is the most available.

Sovereign bonds - bonds issued by a country - will be the most liquid compared to corporate bonds!
GoI bonds
US Treasury
UK Gilts
German Bunds
Japan GB
French Euro
US Treasuries
20 yr
10 yr
5 yr
Why do we stress on liquidity so much?
Because, if a particular bond is not liquid, it will be more expensive!
Imagine you want to buy 2 things in the market -

1 Apartment in Residential South Delhi Easier to buy!
2 Taj Hotel in Mumbai More expensive, more difficult to buy!
Bid Ask Rate!
Is how much the delaer or the broker will pay/ receive for a particular bond.
Bid Buy 100

Ask Sell 101
Profit Spread -1
Thin bid ask spread - a thin bid ask spread means there is lesser issued of liquidity.
More liquidity is available.
Buy 100
Sell 140
Spread -40
Wider bid ask spread - basically means that the bonds have a larger spread to work with
More difficult to buy, less liquidity.
Question Havertz Enterprises have 4 bond issues outstanding. See their bid ask spreads below according to the larges
Explain -
1 Which bonds are the most liquid
2 Which bonds are the least liquid
3 Which bonds were issued recently
4 Which bonds were issued in the past
5 Which bonds are the most expensive
Issue 1 Issue 2 Issue 3 Issue 4

Buy 105 104 104 103
Sell 107 109 110 110
Answer Issue 1 Issue 2 Issue 3 Issue 4

Buy 105 104 104 103
Sell 107 109 110 110
Spread -2 -5 -6 -7
High Liquid Least Liquid
1 Which bonds are the most liquid Issue 1

2 Which bonds are the least liquid Issue 4
3 Which bonds were issued recently Issues 1 and 2
4 Which bonds were issued in the past Issues 3 and 4
5 Which bonds are the most expensive Issues 3 and 4 are the most expensive to buy - buy Issue 4
Keep in Mind - that the Buy price is for a dealer - technically, for a retail investor it is the s
Similarly, sell price for the dealer is the buy price for the retail investor.
THE END
Common Bond Valuation Terminologies - and how to calculate these!
1 Issued at par, premium or discount - this means the bond is issued at a rate above the FV of the bond (premium), or below t
Remember - your coupon would be calculated only based on your FV - irrespective of when/ how much you bought the bond
5% FV MV (Issue Price) Term Coupon Principal repaid

A 100 95 Discount 5 FV = 100
B 100 100 Par 5 FV = 100
C 100 105 Premium 5 FV = 100
2 Duration - sensitivity of the bond to rise/ fall in interest rate!
Assume you invest in an FD @ 8% p.a.
Now, once you invest, your money is locked in for 5 years - you cant take the money out, you cant sell it, or you cant do any
If interest rates increase in FDs to 10% after you make the investment, what happens to the value of your investment?
Your investments value will reduce - why? Because you invested in a FD at lower interest, when everyone else is investing a
There is a linkage between - interest rates and bonds!
Interest rate = Market interest rates
If interest in the market goes up - our bonds go down.

If interest in the market goes down, our bonds go up!
This connection - this answer of how much will my bond value move - this is basically called duration!
This is a sensitivity value of the bond to the market rates!
Beta - the eq to the market
Duration - the bond to the market!
1 Modified is normally used for all securities
2 Effective is normally used for option based securities
3 Macaulay is normally used for cash flow yield related securities
If we say INFY bonds have a duration of 1 - it means, for every 1% increase in market interest rates, there will be a 1 rupee
3 Yield
Yield = Return!
This is how much money a bond makes after you invest in it!
MV Int FV
A 150 10% 100
B 100 10% 100
Paying a lesser amount for the same return (Int + P)
Why will people be dumb enough to purchase Bond A in that case?
Maybe -
1 Bond B has a lower credit quality
2 Bond A might be inflation linked
YTM! Yield To Maturity!
YTM is the present value of a bond calculated based on the future cash flows of the bond.
If the PV > MV = Buy
If the PV < MV = Sell/ Don’t Buy
Example Assume INFY is issuing a Bond at 10% Interest Rate.
The external market interest is 12%.
Assume you want to purchase 1000/- worth of bonds, calculate if the bond is a good buy if the bond is sold at PAR
Tenure - 5 years
If Market Rate > Int Rate Market Rate!
Tenure Cash Flow Amount Discount Rate Discounting V Discounted Cash Flow
P= 1000 1 Int 100 12% 0.8928571429 89.28571429
Int = 10% 2 Int 100 12% 0.7971938776 79.71938776
Int = 100 3 Int 100 12% 0.7117802478 71.17802478
4 Int 100 12% 0.6355180784 63.55180784
5 Int 100 12% 0.5674268557 56.74268557
5 Principle 1000 12% 0.5674268557 567.4268557
1500 927.904476
Present Value of this bond = 927.904476

Market Value of this bond = 1000 Issued at Par
Is the MV < or > ? >
Therefore, do not buy this bond!

If Market Rate < Int Rate
Tenure Cash Flow Amount Discount Rate Discounting V Discounted Cash Flow
P= 1000 1 Int 100 9% 0.9174311927 91.74311927
Int = 10% 2 Int 100 9% 0.8416799933 84.16799933
Int = 100 3 Int 100 9% 0.7721834801 77.21834801
4 Int 100 9% 0.7084252111 70.84252111
5 Int 100 9% 0.6499313863 64.99313863
5 Principle 1000 9% 0.6499313863 649.9313863
1500 1038.896513
Present Value of this bond = 1038.896513

Market Value of this bond = 1000 Issued at Par
Is the MV < or > ? <
Therefore, buy this bond!
Points
1 Market Rate is not constant - will keep changing, so we need to change our analysis accordingly
2 Market Rate is always an assumption!
3 When do you make assumption?
Summarizing!
1 Inflation!
2 Liquidity!
3 Interest Rates !
THE END
Preference Share Capital!
So what is preference capital? It is the ownership of a company for a fixed dividend?
Adv - Fixed Dividend, you know how much to expect!
Cummulative/ Non-Cummulatvie = PSC that is expected to accrue dividends even if the company
2019 Huge loss 100

2020 Profit 100
200 Paid together
Non Cumulative PSC = if in any particular year, you do not get a dividend, that dividend is forfeite
Simple - you pay an x amount and you get a dividend as a portion of the FV of the capital!
FV 100
MV 110
Div 10%
Amount 10
Best way to value preference shares = Gordon DDM
What were the inputs in that model? Preference Shares FV

Dividend
Rate! Rate of Cost of Capital!
Cost of Capital = Dividend

FV
Value of the Share = Dividend
Cost of Capital
Compare the value of the share to the MV -

If Value > MV = Buy!
If Value < MV = Sell!/ Don’t Buy!
Question INFY usually pays a fixed dividend of 100 Rs for every 1000 Rs of share capital.
INFY PS are currently in the market, and are demanded by a lot of people.
You need to find out if INFY is a good buy at inflated rates in the market - MV - 1200
Answer For the Gordon DDM = You need 3 inputs!
Dividend = 100
Cost of Capital = D/ FV = 100/1000 = 10%
Mrket Value = 1200
Value = Dividend
Cost of Capital
= 100
10%
= 1000 This is the value of my share!
Market Value = 1200

Intrinsic Value = 1000
Since IV<MV = Don’t Buy!

Why will companies isue PSC?
1 Fixed dividends - irrespective of how much profit you make, you don’t have to share the
2 Non-Cumm - In case a company is not sure about profit/ loss - non-cumm will ensure yo
After tax dividend! No tax benefit :(
THE END
Derivatives!
So what are derivatives?

Derivatives are basically contracts whose value will change with the change in the underlying!
1 Forward and Future

2 Options
3 Swaps
Forwards and Futures
Forwards and Futures are basically used to lock in a future value!
Imagine you are running a restaurant in Delhi - your main product is the chole bhatura!
You have receive a huge order of 10,000 plates of chole bhatura, in 2 months!
Jan-31
Mar-31
Now what do you need? You need chole!

Chole - 100kgs of chole!
Jan-31 Mar-31
Chole in the market 150/kg
Expected price in March 175/ kg
If I buy my chole in the market on March 31 17,500 Expensive!

If I buy my chole today 15,000 Chole will get spoilt!
Let me enter into a contract to buy this chole today (Jan 31) for March 31 - but I will fix the price today!
When is cotnract entered? Jan-31
When do I pay? Mar-31
When I price decided? Jan-31
Price that will be decided 160/ kg
Jan-31 …………………………………………………………………………… Mar-31
MV 150
But how much

will you pay? 160
Value at expiry -10
I make a profit!
Sell makes a loss!
Chole seller will disappear!
Forward contracts are risky!

Why? Because there is no regulation!
Futures contracts - regulated by exchanges? Stock exchanges! Make sure to regulate this!
Futures contracts are safer!
But, they will be in denominations decided by the exchange!
Value of a FWD/ FUT = MV at EXP - FWD PRICE
Options
Options Contracts give you the right to buy something, but not an obligation.
What does it mean? It means you are allowed to legally say I don’t want to buy it at expiry.
There are two types of options

1 Call - right to buy something
2 Put - right to sell something!
Suppose you buy a call option for chole in the market!
You will buy the right to buy chole by paying a charge!

Is a small amount = premium!
I will buy an option to buy chole at 160/kg. I will buy a call option!
I will pay a premium of 2/ kg
What do you pay? Premium

When do you pay? When you contract - NOW.
How much do you pay? 2*100 = 200.
Now imagine two scenarios
Scenario 1 1 MV of Chole on Mar 31 is 175

Option Strike = 160
Exercise - going ahead with the option

Lapse - forgetting the option!
Exercise the option 16,000

Premium 200
Total Cost of the option! 16,200
Imagine you didn’t enter into the option….
Payment MV = 17,500
Profit 1,300
Scenario 2 Imagine MV is 150
Lapse the option!
You will buy from the market 15,000

Premium 200
Total 15,200
Value of an option = MV - Exercise Price
Swaps Contract!
You can swap something you have for something someone else has!
Mr A Mr B
Loans Fixed Floating
Interest 5% RBI + 1% = 4 + 1 = 5
Expectation Int will go down! Int will go up!
Wants Floating Fixed
Plain Vanilla Swap
Mr A and Mr B will go to a bank, and tell the

bank, please give me floating/ fixed.
Bank will say Ok, but pay me 5k each.
Bank will say, Mr A meet Mr B, Mr B meet Mr A
Mr B pays Fixed to Mr A Mr A pays Floating to Mr B
Mr A pays that Fixed to BMr B pay that floating to the bank.
Value = Difference between the two legs
The END

Valuation

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Valuation

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Look up Ashwath Damodaran!

Valuation is a quantitative process of determining the fait value of an asset ot liability.

Value is always subjective - it differs by the person!

DDLJ - everyone has seen it? The movie!

The experience - there is an intangible value associated with watching it in theater.

The value of an asset = subject + intangible

For me, DDLJ in OTT > DDLJ in theater. Same product.

Simplest Way Ask your neighbor!

Price as a concept is different, and value as a concept is different.

The price of the product is on the sticker.

For EG - we go to a grocery story! We ask for a soap.

Therefore, I will go with Dove - else, go with Cinthol.

Another example - Nivia - sells its shoes at 400/

x Who is allowed to do valuation?

x What do you value?

x Real Life Applications of Valuation

x Different types of assets and liabilities

x Different types of assets and liabilities

Capital and Liabilities (REL) Price/ BS Value

Short Term Liabilities

You walk into a supermarket.

Fixed Assets/ Intangibles

Price? 10L - Depreciation (10L/ 10 = 1L/ year) 3L = 7L

All of this - mention for 2021 alone!

How can we apply this to intangibles?

x Time Value of Money - some examples

What is the answer?

Compounding will tell us which is the better option!

1960 A cup of tea cost 1 Rupee

1960 Avg salary for a graduate was close to 100 rupees

What are we trying to say?

Time value of money is the value of 1 rupee over time!

Money loses its value over time!

For example - I hold a zero coupon bond!

Which means how much is your inherent interest?

We use time value of money calculation.

2021 2022 2023 2024 2025 2026

What value of money in 10 years will equal 10K rupees today?

This rate = rate at which money grows!

Rate = interest + inflation

PV = what value you have today, in our example it is 10,000

Question You have 75,000 in your bank account

What will be the valueis 2750 years?

75000 1.12 2,236,466,220,543,910,000

Question You have 90,000 rupees today!

Principal Multiplicative Value Exponential M ^F FV

Therefore, which is the better option?

if you get 1L after 25 years = 100,000

Therefore, the first option is better, get 10K today!!!!

10,000 today is better than 1L in 25 years!

Tax = I have topay a tax on the gains I enjoyed on this land

Everytime your rate of compounding > discounting = PV go up!

The components involved in a time value of money analysis are below -

Rate of compounding or discounting - Basically depends on the following

Nominal Rate and Real Rate!

Nominal Rate = Real Rate + Inflation

Your FV in the future will also increase

But always remember - we need to have a link between T and R!

Simple Interest Rate - 5%

Because of monthly compounding, Mr X actually makes 2,553 more!

This method requires a lot of assumptions to be made!

Some basics first!