Stock Pricing/Valuation Valuation of Long-Term Securities Valuation of Financial Assets

Equity Financing Stock Equity financing is the sale of ownership of he company for fund raising Stock Stock is the instrument of fund raising and it’s the claim of owners financial asset on the real assets of the company without any promised of dividend

Stock is arguable than there will be subjectivity Stock is arguable than there will be subjectivity. If it subjectivity there will be variation and higher will be uncertainty and higher will be risk Life of company is unlimited then the stock will be unlimited If company is ongoing concern then stock will be ongoing concern

Undisputable Disputable Stocks Bonds Dividend Not Fixed Market Price of Share (MPS) Variation in share price volatility Coupon Fixed % of Face Value (FV) Face Value Fixed price written on the bond

Pricing of Bond Pricing Pricing is the PV of future cash flow discounted at appropriate discount rate PB = C1_ _ + C2_ _ + . . . . . . . . + FV__ (1 + kd)1 (1 + kd)2 (1 + kd)t Bond = kd = Cost of Debt Stock = ke = Cost of Equity Loan = i = Cost of Loan

Pricing of Stock Ps = D1_ _ + D2_ _ + . . . . . .(on going stock) (1 + ke)1 (1 + ke)2 Ps = D1_ _ + D2_ _ + . . . . . . . . + MPS_ _ (1 + ke)1 (1 + ke)2 (1 + ke)t If resolved at maturity Unlimited Limited

Types of Stock Irredeemable Redeemable Ps (Unlimited) Unlimited life of stock like common stock Ps (limited) Company will buy the stock at maturity

Techniques of Pricing/Valuation the Stock Relative Models Cash Based Models Dividend Based Models Value Added Models

Relative Models All information will be taken from market and books Price Earning Ratio P/E = MPS EPS Market to Book Ratio P/BV = MPS___ BV per share

Relative Models Sales to Price Ratio S/P= Sales per Share MPS If overall = Total Sales_ ___ Market Capitalization Market Capitalization=MPS * No. of shares outstanding

Relative Models EBIT to Price Ratio Cash to Price Ratio EBIT of per Share MPS Cash to Price Ratio = Cash dividend per share

Cash Based Models Free Cash Flow Approach FCF Residual Equity Cash Flow Approach RECF Adjusted Present Value Approach APV

Dividend Based Models No Growth Model Constant Growth Model Supper Normal Growth Model OR Phased Growth Model 2 or 3 Stage Growth Model

Value Added Models Economic Value Added Market Value Added EVA Market Value Added MVA Cash Value Added CVA

Relative Model Price Earning Ratio P/E= MPS EPS Company MPS EPS P/E Fair MPS Decision A 40 20 40/20= 2 1.65*20= 33 Overvalued Sell B 10 8 10/8= 1.25 1.65*8= 13.2 Undervalued Buy C 100 60 100/60= 1.67 1.65*60= 99 D 5 3 5/3= 1.67 1.65*3= 4.95

Relative Model Price Earning Ratio (P/E) of Industry = S (P/E) _ = 6.59 =1.65 No. of Companies 4 If there is variation/subjectivity than there will be difference in between the actual and estimated/ fair price Fair MPS = (P/E) of Industry * EPS Overvalued  IF fair price is less than the MPS Undervalued  IF fair price is greater than the MPS

Relative Model Sales to Price Ratio Company Total Sale No. of Shares MPS Sales per Share S/P Fair MPS Decision 1 10000 50 40 10000/50= 200 200/40= 5 200/17.8= 11.23 Overvalued Sell 2 5000 20 30 5000/20= 250 250/30= 8.3 250/17.8= 14.04 3 8000 10 8000/10= 800 800/20= 800/17.8= 44.94 Undervalued Buy

Relative Model Sales to Price Ratio S/P= Sales per Share MPS Sales per Share = Total Sales _ No. of Shares When same market is efficient (S/P) of Industry = S (S/P) _ = 53.3 =17.8 No. of Companies 3 Fair MPS = Sales per Share_ (S/P) of Industry

Free Cash Flow Cash flows which are available to distribute between bond holder (debt provider) and share holder (equity provider) after fulfilling the business requirement Requirement Operating Expenses/CGS Tax Working Capital Expenditure (Investment in Fixed Asset)

Free Cash Flow FCF = EBIT (1-Tax) + Depreciation + NWC + Capital Expenditure EBIT = Earning Before Interest & Tax NWC = Change In Net Working Capital NWC = Net Working Capital WC = Current Assed (CA) NWC = CA – CL

Free Cash Flow No. Of Shares MPS = VE _ VE = Vc – Vd VE = Value of Equity VE = Vc – Vd Vc = Value of Company Vd = Value of Debt

Free Cash Flow VC = FCF (1+ gFCF ) WAVV – gFCF gFCF = Growth Rate of FCF WACC = Weighted Average Cost of Capital gFCF (i/r) = (FVFCF/PVFCF) 1/t – 1

Free Cash Flow WAAC = WeKe – WdKd (1- Tax) We = Weigh of Equity Ke = Cost of Equity Wd = Weigh of debt Kd = Cost of debt

Free Cash Flow Ke = Rf + b (Rm - Rf) Rf = Risk Free Rate (T-Bill Rate) Rm = Market Risk b = Systematic Risk

Choice of Growth Rate CAGR SAGR Cumulative Annual Growth Rate If there is continuous increase pattern in FCF’s/ almost Simple Average Growth Rate If there is trend of increase or decrease Growth rate will be calculated per year

Question Year EBIT Depreciation Capital Expenditure 2010 5000 500 600 If NWC is 10% of EBIT and Tax is 30% of EBIT Rf = 5% Kd = 10% Rm = 15% Vd = 2200 b = 1.5 % D:E= 40:60 Wd = 0.4 We = 0.6 gFCF = 5.3% Tax = 30% t = 5 PVFCF = 3700 Value of shares = 1000 FVFCF = 4780 Year EBIT Depreciation Capital Expenditure 2010 5000 500 600 2011 5500 2012 6000 2013 2014 5800 2015 7000

Solution Expenditure NWC = Current NWC – Previous NWC Year EBIT Depreciation Capital Expenditure NWC 2010 5000 500 600 -- 2011 5500 550 50 2012 6000 2013 2014 5800 580 -20 2015 7000 700 120 NWC = Current NWC – Previous NWC FCF = EBIT (1-Tax) + Depreciation + NWC + Capital Expenditure

Solution gFCF = (FVFCF/PVFCF) 1/t – 1 gFCF = (4780/3700) 1/5 – 1 2010 2011 2012 2013 2014 2015 EBIT 5000 5500 6000 5800 7000 Tax (1500) (1650) (1800) (1740) (2100) Depreciation 500 NWC -- (50) 20 (120) Capital Expenditure (600) (500) FCF 3700 4150 4200 4080 4780 gFCF = (FVFCF/PVFCF) 1/t – 1 gFCF = (4780/3700) 1/5 – 1 gFCF = 0.053 gFCF =5.3%

Solution Ke = Rf + b (Rm - Rf) Ke = 0.05 + 1.5(0.15 – 0.05) Ke = 0.2 WAAC = WeKe – WdKd (1- Tax) WAAC = 0.60 (0.20) – (0.40)(0.10)(1 – 0.3) WAAC = 0.12 – 0.04 (0.7) WAAC = 0.092 WAAC = 9.%

Solution VC = FCF (1+ gFCF ) WAVV – gFCF VC = 4780 (1 + 0.053) 0.092 – 0.053 VC = 129060 VE = Vc – Vd VE = 129060 – 22000 VE =107060

Solution MPS = VE _ No. Of Shares MPS = 107060 1000 MPS = 107.60