Concept Check: Stock Valuation
• Valuing stocks: Cashflows (dividends) , Appropriate discount rate (r) ?
How do you estimate discount rate?
• Let g(t) be the growth from EPS(t-1) to EPS (t), then
g(t) = Retention ratio (t-1) x ROE (t)
• Justified PE
Concept Check: Capital Budgeting
• NPV of Project: Project Cashflows, Discount Rate: WACC (Firm Level < Division Level < Project Level)
• Sunk cost (or benefit)
• Overheads
• After-tax Profits
• Opportunity Cost
• Depreciation tax Savings
• Salvage value assumed for depreciation purpose vs. Actual expected Salvage value
• Capital Gains Tax / Capital Loss Tax
• Working Capital 2
A company just paid a dividend of Rs.1.60 per share on its common
stock. The company expects to increase the dividend at 20% for the
first two years and at a 13% for the next two years, and then grow at
7% thereafter. This phased growth pattern is in keeping with the
expected life cycle of earnings. You expect to earn a 16% return by
investing in this stock. What value should you place on a share of this
stock?
Ans: 25.98
A company paid a dividend of INR 7 recently. It is
expected to grow at 6% indefinitely. It has an ROE of
20%. If the share is trading at 106, calculate the
present value of growth opportunities.
• Ans: 29.08
ABC Inc. had an EPS of INR 10 in the year just concluded. The company has an ROE
of 20% which is expected to continue forever. The company currently retains 60% of
its earnings and expects to do so for another 3 years. After that, the investment
opportunities would reduce and hence the company expects to be paying out 80%
of its earnings (starting year 4). The cost of equity for this company is 10%.
a. What is the present value per share for this company?
• 170.07
b. What is the value of assets-in-place ? (Value of firm assuming it has no growth in earnings)
• 100
c. If the company had a stable growth of 4% from beginning, what will be the price? As earlier,
assume current year EPS is 10.
• 138.67
d. How much additional value is added due to the company having a high-growth period?
• 31.4
Value of assets-in-place is the value that would exist if the company had no growth.
Stable growth is the growth which the company can maintain in perpetuity.
XYZ is in the business of supplying electricity to Udaipur city. The
current EPS and DPS are INR 3.13 and INR 2.19, respectively. The
return on equity for XYZ is 11.63%. The beta for XYZ is 0.90; the
risk free rate is 5.4% and market risk premium is 4%. What should
be the share price for XYZ if it is in a stable growth phase?.
Ans: 41.15
A firm has invented a product which has received a phenomenal response, so
all earnings are reinvested to expand operations. Earnings were INR 2 per
share in the current year and are expected to grow at a rate of 20% per year
until the end of year 4. At that point, it is likely there would be competing
products. Analysts project that at the end of year 4, firm will begin paying
60% of its earnings as dividends, and earnings growth rate will slow to a long
run stable rate of 4%. If firm’s equity cost of capital is 8%, what is the value of
the share today?
Ans: 49.4
