Final Project Report

1 EXECUTIVE SUMMARY
Valuation is the process of determining the real value (intrinsic value) as opposed to the observed market price of a security. Different methods give different intrinsic value of company and also in each method there are different growth and different forces which drive the security price the problem lies in which intrinsic value to choose.
The goal of such an appraisal is essentially to estimate a fair market value of a company. The fair market value is the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.
In this project three different methods namely free cash flows to equity, dividend discount model and PE multiplier model are done and the drivers of each model are calculated.
One industry namely large capitalization information technology (IT) is considered and twenty companies in IT large cap industry are analysis and the intrinsic value for these companies is calculated using three methods which considered.
In each method the market value is compared with the intrinsic value for each company and whether the share price is overvalued or undervalued is decided.
Finally the market price is compared with the intrinsic values of three methods and a consolidated, that is whether market share price is overvalued or undervalued is decided.
ALLIANCE BUSINESS ACADEMY
INTRODUCTION
3 1.1 INTRODUCTION
Every asset, financial as well as real, has a value. The key to successfully investing in and managing these assets lies in understanding not only what the value is but also the sources of the value. Any asset can be valued, but some assets are easier to value than others and the details of valuation will vary from case to case. Thus, the valuation of a share of a real estate property will require different information and follow a different format than the valuation of a publicly traded stock. What is surprising; however, is not the difference in valuation techniques across assets, but the degree of similarity in basic principles.
There is undeniably uncertainty associated with valuation. Often that uncertainty comes from the asset being valued, though the valuation model may add to that uncertainty. In the wake of economic liberalization, companies are relying more on the capital market, acquisitions and restructuring are becoming common place, strategic alliances are gaining popularity, employee stock option plans are proliferating, and regulatory bodies are struggling with tariff determination. In these exercises a crucial issue is: how should the value of a company or a division thereof is appraised.
The goal of such an appraisal is essentially to estimate a fair market value of a company. The fair market value is the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. When the asset being appraised is a company, the property the buyer and the seller are trading consists of the claims of all the investors of the company; this includes outstanding equity shares, preference shares, debentures and loans.
1.2 OVERVIEW OF VALUATION

Analysts use a wide spectrum of models, ranging from the simple to the sophisticated. These models often make very different assumptions about the fundamentals that determine value, but they do share some common characteristics and can be classified in broader terms. There are several advantages to such a classification --it makes it is easier to understand where individual
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models fit in to the big picture, why they provide different results and when they have fundamental errors in logic.
In general terms, there are four approaches to valuation. The first, discounted cashflow valuation, relates the value of an asset to the present value of expected future cashflows on that asset. The second, liquidation and accounting valuation is built around valuing the existing assets of a firm, with accounting estimates of value or book value often used as a starting point. The third, relative valuation, estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales. The final approach, contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics. This is what generally falls under the rubric of real options.
1.3 THE ROLE OF VALUATION

Valuation is useful in a wide range of tasks. The role it plays however is different in different arenas. The following section lays out the relevance of valuation in portfolio management, in acquisition analysis, and in corporate finance.
1. VALUATION AND PORTFOLIO MANAGEMENT

The role that valuation plays in portfolio management is determined in large part by the investment philosophy of the investor. Valuation plays a minimal role in portfolio management for a passive investor, whereas it plays a larger role for an active investor. Even among active investors, the nature and the role of valuation is different for different types of active investment. Market timers use valuation much less than investors who pick stocks and the focus is on market valuation rather than on firm specific valuation. Among security selectors, valuation plays a central role in portfolio management for fundamental analysts and a peripheral role for technical analysts.
2. VALUATION IN ACQUISITION ANALYSIS

Valuation should play a central part in acquisition analysis. The bidding firm or individual has to decide on a fair value for the target firm before making a bid, and the target firm has to
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determine a reasonable value for itself before deciding to accept or reject the offer. There are also special factors to consider in takeover valuation. First the effects of synergy on the combined value of the two firms (target plus bidding firm) have to be considered before a decision is made on the bid. Those who suggest that synergy is impossible to value and, therefore should not be considered in quantitative terms are wrong. Second the effects on value of changing management and restructuring the target firm will have to be taken into account in deciding on a fair price. This is of particular concern in hostile takeovers. Finally there is a significant problem with bias in the takeover valuations. Target firms may be overoptimistic in estimating value, especially when the takeover is hostile and they are trying to convince their shareholders that the offer price is too low. Similarly if the bidding firm has decided, for strategic reasons, to do an acquisition, there may be strong pressure on the analyst to come up with an estimate of value that backs up the acquisition.
3. VALUATION IN CORPORATE FINANCE

In recent years, management consulting firms have started offering companies advice on how to increase value. This has been possible because of the fear of hostile takeovers. Companies have increasingly turned to .value consultants. To tell them how to restructure, increase value, and avoid being taken over. The consultants. Suggestions have often provided the basis for the restructuring of these firms. The value of a firm can be directly related to decisions that it makes: on which projects it takes, on how it finances them, and on its dividend policy. Understanding this relationship is key to making value increasing decisions and to sensible financial restructuring.
APPROACHES TO VALUATION
There are four broad approaches to appraising the value of a company namely 1. Adjusted book value approach 2. Stock and debt approach 3. Relative Valuation and 4. Discounted cash flow approach.
6 1.ADJUSTED BOOK VALUE APPROACH

The simplest approach to valuing a firm is to rely on the information found on its balance sheet. There are two equivalent ways of using the balance sheet information to appraise the value of a firm. First, the book values of investor claims may be summed directly. Second, the assets of a firm may be totaled and from this total non-investor claims (like accounts payable and provisions) may be deducted. The accuracy of the book value approach depends on how well the net book values of the assets reflect their fair market values.
2. STOCK AND DEBT APPROACH

When the securities of a firm are publicly traded, its value can be obtained by merely adding the market value of all its outstanding securities. This simple approach is called the stock and the debt approach by property tax appraisers. It is also referred to as the market approach.
3. RELATIVE VALUATION
While we tend to focus most on discounted cash flow valuation, when discussing valuation, the reality is that most valuations are relative valuations. The value of most assets, from the house you buy to the stocks that you invest in, are based upon how similar assets are priced in the market place. We begin this section with a basis for relative valuation, move on to consider the underpinnings of the model and then consider common variants within relative valuation. In relative valuation, the value of an asset is derived from the pricing of comparable' assets, standardized using a common variable such as earnings, cash flows, book value or revenues. One illustration of this approach is the use of an industry-average price-earnings ratio to value a firm. This assumes that the other firms in the industry are comparable to the firm being valued and that the market, on average, prices these firms correctly. Another multiple in wide use is the price to book value ratio, with firms selling at a discount on book value, relative to comparable firms, being considered undervalued. The multiple of price to sales is also used to value firms, with the average price-sales ratios of firms with similar characteristics being used for comparison. While these three multiples are among the most widely used, there are others that also play a role in analysis - price to cash flows, price to dividends and market value to replacement value (Tobin's Q), to name a few.
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Categorizing Relative Valuation Models Analysts and investors are endlessly inventive when it comes to using relative valuation. Some compare multiples across companies, while others compare the multiple of a company to the multiples it used to trade in the past. While most relative valuations are based upon comparables, there are some relative valuations that are based upon fundamentals.
A. USING FUNDAMENTALS
The first approach relates multiples to fundamentals about the firm being valued growth rates in earnings and cashflows, payout ratios and risk. This approach to estimating multiples is equivalent to using discounted cashflow models, requiring the same information and yielding the same results. Its primary advantage is to show the relationship between multiples and firm characteristics, and allows us to explore how multiples change as these characteristics change. For instance, what will be the effect of changing profit margins on the price/sales ratio? What will happen to price-earnings ratios as growth rates decrease? What is the relationship between price-book value ratios and return on equity?
B. USING COMPARABLES
The more common approach to using multiples is to compare how a firm is valued with how similar firms are priced by the market, or in some cases, with how the firm was valued in prior periods. As we will see in the later chapters, finding similar and comparable firms is often a challenge and we have to often accept firms that are different from the firm being valued on one dimension or the other. When this is the case, we have to either explicitly or implicitly control for differences across firms on growth, risk and cash flow measures. In practice, controlling for these variables can range from the naive(using industry averages) to the sophisticated (multivariate regression models where the relevant variables are identified and we control for differences.).
C. CROSS SECTIONAL VERSUS TIME SERIES COMPARISONS

In most cases, analysts price stocks on a relative basis by comparing the multiple it is trading to the multiple at which other firms in the same business are trading. In some cases, however, especially for mature firms with long histories, the comparison is done across time.
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a) CROSS SECTIONAL COMPARISONS When we compare the price earnings ratio of a software firm to the average price earnings ratio of other software firms, we are doing relative valuation and we are making cross sectional comparisons. The conclusions can vary depending upon our assumptions about the firm being valued and the comparable firms. For instance, if we assume that the firm we are valuing is similar to the average firm in the industry, we would conclude that it is cheap if it trades at a multiple that is lower than the average multiple. If, on the other hand, we assume that the firm being valued is riskier than the average firm in the industry, we might conclude that the firm should trade at a lower multiple than other firms in the business. In short, you cannot compare firms without making assumptions about their fundamentals.
b) COMPARISONS ACROSS TIME If you have a mature firm with a long history, you can compare the multiple it trades today to the multiple it used to trade in the past. Thus, Ford Motor company may be viewed as cheap because it trades at six times earnings, if it has historically traded at ten times earnings. To make this comparison, however, you have to assume that your firm has not changed its fundamentals over time. For instance, you would expect a high growth firms price earnings ratio to drop and its expected growth rate to decrease over time as it becomes larger. Comparing multiples across time can also be complicated by changes in the interest rates over time and the behavior of the overall market. For instance, as interest rates fall below historical norms and the overall market increases, you would expect most companies to trade at much higher multiples of earnings and book value than they have historically.
D. STANDARDIZED VALUES AND MULTIPLES

The price of a stock is a function both of the value of the equity in a company and the number of shares outstanding in the firm. Thus, a stock split that doubles the number of units will approximately halve the stock price. Since stock prices are determined by the number of units of equity in a firm, stock prices cannot be compared across different firms. To compare the values of similar firms in the market, you need to standardize the values in some way. Values can be standardized relative to the earnings firms generate, to the book value or replacement value of
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the firms themselves, to the revenues that firms generate or to measures that are specific to firms in a sector.
1. EARNINGS MULTIPLES
One of the more intuitive ways to think of the value of any asset is the multiple of the earnings that asset generates. When buying a stock, it is common to look at the price paid as a multiple of the earnings per share generated by the company. This price/earnings ratio can be estimated using current earnings per share, yielding a current PE, earnings over the last 4 quarters, resulting in a trailing PE, or an expected earnings per share in the next year, providing a forward PE. When buying a business, as opposed to just the equity in the business, it is common to examine the value of the firm as a multiple of the operating income or the earnings before interest, taxes, depreciation and amortization (EBITDA). While, as a buyer of the equity or the firm, a lower multiple is better than a higher one. These multiples will be affected by the growth potential and risk of the business being acquired.
2. BOOK VALUE OR REPLACEMENT VALUE MULTIPLES

While markets provide one estimate of the value of a business, accountants often provide a very different estimate of the same business. The accounting estimate of book value is determined by accounting rules and is heavily influenced by the original price paid for assets and any accounting adjustments (such as depreciation) made since. Investors often look at the relationship between the price they pay for a stock and the book value of equity (or net worth) as a measure of how over- or undervalued a stock is; the price/book value ratio that emerges can vary widely across industries, depending again upon the growth potential and the quality of the investments in each. When valuing businesses, you estimate this ratio using the value of the firm and the book value of all assets (rather than just the equity). For those who believe that book value is not a good measure of the true value of the assets, an alternative is to use the replacement cost of the assets; the ratio of the value of the firm to replacement cost is called Tobins Q.
10 3. REVENUE MULTIPLES
Both earnings and book value are accounting measures and are determined by accounting rules and principles. An alternative approach, which is far less affected by accounting choices, is to use the ratio of the value of an asset to the revenues it generates. For equity investors, this ratio is the price/sales ratio (PS), where the market value per share is divided by the revenues generated per share. For firm value, this ratio can be modified as the value/sales ratio (VS), where the numerator becomes the total value of the firm. This ratio, again, varies widely across sectors, largely as a function of the profit margins in each. The advantage of using revenue multiples, however, is that it becomes far easier to compare firms in different markets, with different accounting systems at work, than it is to compare earnings or book value multiples.
4. SECTOR-SPECIFIC MULTIPLES
While earnings, book value and revenue multiples are multiples that can be computed for firms in any sector and across the entire market, there are some multiples that are specific to a sector. For instance, when Internet firms first appeared on the market in the later 1990s, they had negative earnings and negligible revenues and book value. Analysts looking for a multiple to value these firms divided the market value of each of these firms by the number of hits generated by that firms web site. Firms with a low market value per customer hit were viewed as more undervalued. More recently, retailers have been judged by the market value of equity per customer in the firm, regardless of the longevity and the profitably of the customers. While there are conditions under which sector-specific multiples can be justified, they are dangerous for two reasons. First, since they cannot be computed for other sectors or for the entire market, sector-specific multiples can result in persistent over or under valuations of sectors relative to the rest of the market.
11 4. DISCOUNTED CASH FLOW VALUATION BASIS FOR DISCOUNTED CASH FLOW VALUATION
This approach has its foundation in the present value rule, where the value of any asset is the present value of expected future cash flows that the asset generates. Value =
Where, n = Life of the asset CFt = Cashflow in period t r = Discount rate reflecting the riskiness of the estimated cashflows. The cashflows will vary from asset to asset -- dividends for stocks, coupons (interest) and the face value for bonds and after-tax cashflows for a real project. The discount rate will be a function of the riskiness of the estimated cashflows, with higher rates for riskier assets and lower rates for safer projects. You can in fact think of discounted cash flow valuation on a continuum. t one end of the spectrum, you have the default-free zero coupon bond, with a guaranteed cash flow in the future. Discounting this cash flow at the riskless rate should yield the value of the bond. A little further up the spectrum are corporate bonds where the cash flows take the form of coupons and there is default risk. These bonds can be valued by discounting the expected cash flows at an interest rate that reflects the default risk. Moving up the risk ladder, we get to equities, where there are expected cash flows with substantial uncertainty around the expectation. The value here should be the present value of the expected cash flows at a discount rate that reflects the uncertainty.
CATEGORIZING DISCOUNTED CASH FLOW MODELS

There are literally thousands of discounted cash flow models in existence. Oftentimes, we hear claims made by investment banks or consulting firms that their valuation models are better or more sophisticated than those used by their contemporaries. Ultimately, however, discounted
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cash flow models can vary only a couple of dimensions and we will examine these variations in this section.
TOTAL CASH FLOW VERSUS EXCESS CASH FLOW MODELS

The conventional discounted cash flow model values an asset by estimating the present value of all cash flows generated by that asset at the appropriate discount rate. In excess return (and excess cash flow) models, only cash flows earned in excess of the required return are viewed as value creating, and the present value of these excess cash flows can be added on to the amount invested in the asset to estimate its value. Excess return = Cash flow earned Cost of capital * Capital Invested in asset
FREE CASH FLOW TO EQUITY DISCOUNT MODELS

The dividend discount model is based upon the premise that the only cashflows received by stockholders is dividends. Even if we use the modified version of the model and treat stock buybacks as dividends, we may misvalue firms that consistently return less or more than they can afford to their stockholders.
FREE CASH FLOWS TO EQUITY

To estimate how much cash a firm can afford to return to its stockholders, we begin with the net income the accounting measure of the stockholders earnings during the period and convert it to a cash flow by subtracting out a firms reinvestment needs. First, any capital expenditures, defined broadly to include acquisitions, are subtracted from the net income, since they represent cash outflows. Depreciation and amortization, on the other hand, are added back in because they are non-cash charges. The difference between capital expenditures and depreciation is referred to as net capital expenditures and is usually a function of the growth characteristics of the firm. High growth firms tend to have high net capital expenditures relative to earnings, whereas low-growth firms may have low, and sometimes even negative, net capital expenditures. Second, increases in working capital drain a firms cash flows, while decreases in working capital increase the cash flows available to equity investors. Firms that are growing fast, in
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industries with high working capital requirements (retailing, for instance), typically have large increases in working capital. Since we are interested in the cash flow effects, we consider only changes in non-cash working capital in this analysis. Finally, equity investors also have to consider the effect of changes in the levels of debt on their cash flows. Repaying the principal on existing debt represents cash outflow; but the debt repayment may be fully or partially financed by the issue of new debt, which is a cash inflow. Again, netting the repayment of old debt against the new debt issues provides a measure of the cash flow effects of changes in debt. Allowing for the cash flow effects of net capital expenditures, changes in working capital and net changes in debt on equity investors, we can define the cash flows left over after these changes as the free cash flow to equity (FCFE). Free Cash Flow to Equity (FCFE) = Net Income - (Capital Expenditures - Depreciation) (Change in Non-cash Working Capital) + (New Debt Issued - Debt Repayments) This is the cash flow available to be paid out as dividends or stock buybacks. This calculation can be simplified if we assume that the net capital expenditures and working capital changes are financed using a fixed mix1 of debt and equity.
THE FREE CASHFLOW TO THE FIRM

The free cashflow to the firm is the sum of the cashflows to all claim holders in the firm, including stockholders, bondholders and preferred stockholders. There are two ways of measuring the free cashflow to the firm (FCFF). One is to add up the cashflows to the claim holders, which would include cash flows to equity (defined either as free cash flow to equity or dividends), cashflows to lenders (which would include principal payments, interest expenses and new debt issues) and cash flows to preferred stockholders (usually preferred dividends). FCFF = Free Cashflow to Equity + Interest Expense (1 - tax rate) + Principal Repayments New Debt Issues+ Preferred Dividends Note, however, that we are reversing the process that we used to get to free cash flow to equity, where we subtracted out payments to lenders and preferred stockholders to estimate the cash flow left for stockholders. A simpler way of getting to free cash flow to the firm is to estimate the cash flows prior to any of these claims. Thus, we could begin with the earnings before
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interest and taxes, net out taxes and reinvestment needs and arrive at an estimate of the free cash flow to the firm. FCFF = EBIT (1 - tax rate) + Depreciation - Capital Expenditure Since this cash flow is prior to debt payments, it is often referred to as an unlevered cash flow. Note that this free cash flow to the firm does not incorporate any of the tax benefits due to interest payments. This is by design, because the use of the after-tax cost of debt in the cost of capital already considers this benefit and including it in the cash flows would double count it.
THE MODEL
The value of the firm, in the most general case, can be written as the present value of expected free cashflows to the firm. Value of Firm =
Where, FCFFt = Free Cashflow to firm in year t. WACC = Weighted average cost of capital.
DIVIDEND DISCOUNT MODELS

In the strictest sense, the only cash flow you receive from a firm when you buy publicly traded stock is the dividend. The simplest model for valuing equity is the dividend discount model -- the value of a stock is the present value of expected dividends on it. While many analysts have turned away from the dividend discount model and viewed it as outmoded, much of the intuition that drives discounted cash flow valuation is embedded in the model. In fact, there are specific companies where the dividend discount model remains a useful tool for estimating value.
THE GENERAL MODEL

When an investor buys stock, she generally expects to get two types of cashflows - dividends during the period she holds the stock and an expected price at the end of the holding period.
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Since this expected price is itself determined by future dividends, the value of a stock is the present value of dividends through infinity. Value per share of stock =
Where, DPSt = Expected dividends per share Ke = Cost of equity There are two basic inputs to the model - expected dividends and the cost on equity. To obtain the expected dividends, we make assumptions about expected future growth rates in earnings and payout ratios. The required rate of return on a stock is determined by its riskiness, measured differently in different models - the market beta in the CAPM, and the factor betas in the arbitrage and multi-factor models. The model is flexible enough to allow for time-varying discount rates, where the time variation is caused by expected changes in interest rates or risk across time.
THE GORDON GROWTH MODEL

The Gordon growth model can be used to value a firm that is in 'steady state' with dividends growing at a rate that can be sustained forever.
THE MODEL
The Gordon growth model relates the value of a stock to its expected dividends in the next time period, the cost of equity and the expected growth rate in dividends. Value of Stock =
Where, DPS1 = Expected Dividends one year from now (next period) Ke = Required rate of return for equity investors G = Growth rate in dividends forever
16 METHODS USED FOR VALUATIONS:1. VALUATION PARAMETERS:The following parameters are used for valuing the companies:1. Net operating profit less adjusted taxes (NOPLAT) 2. Return on capital employed (ROCE) 3. Growth rate 4. Weighted average cost of capital 5. Free cash flow (FCFF) As per the sample size ten companies representing information technology industry are analyzed by four different techniques those are 1. Free cash flows to equity. 2. Dividend discount model. 3. PE ratio method. 4. Direct comparison approach.
2. FREE CASH FLOWS TO EQUITY:Value of high - growth business =
FREE CASH FLOWS TO FIRM
PARTICULARS SALES LESS:-COGS EBIT
AMOUNT XXX XXX XXX
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LESS:-TAX EBIT (1-T) LESS: - CHANGE IN WORKING CAPITAL FCFF XXX XXX XXX XXX
3. TERMINAL VALUE
The terminal value of a security is the present value at a future point of all future cash flows. It allows for the inclusion of the value of future cash flows occurring beyond a several year projection period while satisfactorily mitigating many of the problems of valuing such cash lows. The terminal value is calculated in accordance with a stream of projected future free cash flows in discounted cash flow analysis. Terminal value=final projected year cash flow/ (WACCgrowth rate) Once the terminal values and operating cash flows have been estimated, they are discounted back to the present to yield the value of the operating assets of the firm.
Fair value of equity = FCFF - Total Debt. Value of each equity share = fair value of equity/total number of equity shares.
4. DIVIDEND DISCOUNT MODEL:-
THE GORDON GROWTH MODEL

The Gordon growth model can be used to value a firm that is in 'steady state' with dividends growing at a rate that can be sustained forever. The Gordon growth model relates the value of a stock to its expected dividends in the next time period, the cost of equity and the expected growth rate in dividends.
VALUE OF STOCK = DPS1/ KE G

Where, DPS1 = Expected Dividends one year from now (next period) Ke= required rate of return for equity investors
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g = Growth rate in dividends forever g =Growth rate = ROC* b Where, Roc = return on equity & b = retention ratio. DPS1 = DPS0 (1+g). Here ke is calculated using share price of stock for last 5 years. Roc & b are calculated for last 5 years using financial statements of those companies.
5. PRICE EARNINGS RATIO (PE)

The price-earnings multiple (PE) is the most widely used and misused of all multiples. Its simplicity makes it an attractive choice in applications ranging from pricing initial public offerings to making judgments on relative value, but its relationship to a firm's financial fundamentals is often ignored, leading to significant errors in applications.
Definitions of PE ratio is the price earnings ratio is the ratio of the market price per share to the
consistently defined, with the numerator being the value of equity per share and the denominator measuring earnings per share, both of which is a measure of equity earnings.
Actual process is that the PE ratio of first ten companies are calculated individually and then depending on the market share of each company further the weight of each company is calculated on the basis of percentage of these companies market share. And then the industry average PE ratio is decided. When this industry PE ratio is compared with the actual PE ratio of each company in order to decide whether the stock is over prices or under prices.
19 1.4 RESEARCH PROPOSAL NEED FOR THE STUDY / STATEMENT OF PROBLEM VALUATION OF EQUITY SHARE PRICES
There are different methods for analyze an equity share price and the inputs needed for each method is different. So each method generates different intrinsic value of the equity share price and the problem is which value to choose. In some cases the difference between price generated by different method is slightly varied in other cases price variation is wide so the problem is whether to take an average value or to ignore the value which widely different from other methods and to arrive at the right value.
OBJECTIVES OF THE STUDY

To understand and analyze investment process and capital market thoroughly To analyze the parameters to evaluate or value an equity share price. To compare the value of the firm with that of market value of share. To find a fair intrinsic value of the company using different methods.
SCOPE OF THE STUDY

It is essential that strategic decisions for companies are based on accurate information. Whether while buying, selling, merging, restructuring or raising additional capital, it is imperative to know the value of a company. Accurate valuation helps in making prudent investments and strategic decisions. Valuations are critical components of nearly all financial transactions. The demand of corporations and industrial practitioners to optimize value for commercial purposes has driven the need to utilize valuation as a strategic corporate tool. Valuation or the estimate of the current market value of an asset is found in all business and in all dimensions.
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REVIEW OF LITRETURE
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Review of literature means examining and analyzing the various literatures available in any field either for references purposes or for further research. Further research can be done by identifying the areas which have not been studied and in turn undertaking research to add value to the existing literature. For the purpose of literature review various sources of information have been used. Sources include books, journals as well as some literature papers.
2.1.1The valuation of cash flows forecasts: an empirical analysis By: Steven n. Kaplan and Richard s.ruback
The study provides evidence that discount cash flow valuation methods provide reliable estimates of market value. their median estimates of discounted cash flows for 51 highly leveraged transactions (HLTS) are within 10 percent of the market values of the completed transactions and perform at least as well as valuation approaches using companies in similar industries and companies involved in similar transactions .the stress on estimates rely on a number of ad hoc assumptions that should be able to improve on. the research expect such improvements to bring the DCF valuations even closer to the transaction values.
Three CAPM-based approaches are use to estimate discount rate corresponding to firm-level, industry-level, and market-level measures of risk. All three methods perform well compared to those using comparable transactions and companies. They considered the most realistic assumptions; the industry- and market-based approaches perform best. In the second part, the forecasted cash flows and transaction values are calculated using discount rates and risk premium. The median implied market equity risk premium, the amount by which the return on the equity market exceeds the long-term Treasury bond yield, equals 7.78 percent. This accords well with the historical risk premium by which returns on the S&P 500 have exceeded Treasury bond returns. The relations between the implied risk premium and both firm and industry betas are positive and marginally significant. In contrast, there are no apparent relations between the implied risk premium and either transaction value.
22 2.1.2VALUATION APPROACHES AND METRICS: A SURVEY OF THE THEORY AND EVIDENCE (NOVEMBER 2006) Aswath Damodaran Stern School of Business
Overview of the survey Since almost everything in finance can be categorized as a subset of valuation and They run the risk of ranging far from their mission, they kept a narrow focus in this paper. In particular, they stressed away any work done on real options, since it merits its own survey article. In addition, they kept their focus on papers that have examined the theory and practice of valuation of companies and stocks, rather than on questions of assessing risk and estimating discount rates that have consumed a great deal of attention in the literature. In general terms, there are four approaches to valuation. The first, discounted cashflow valuation, relates the value of an asset to the present value of expected future cashflows on that asset. The second, liquidation and accounting valuation is built around valuing the existing assets of a firm, with accounting estimates of value or book value often used as a starting point. The third, relative valuation, estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales. The final approach, contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics. This is what generally falls under the rubric of real options.
Directions for future research As the survey, the research done on valuation in the last few decades, there are three key trends that emerge from the research. First, the focus has shifted from valuing stocks through models such as the dividend discount model to valuing businesses, representing the increased use of valuation models in acquisitions and corporate restructuring (where the financing mix is set by the acquirer) and the possibility that financial leverage can change quickly over time. Second, the connections between corporate finance and valuation have become clearer as value is linked to a firms actions.
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In particular, the excess return models link value directly to the quality of investment decisions, whereas adjusted present value models make value a function of financing choices. Third, the comforting conclusion is that all models lead to equivalent values, with consistent assumptions, which should lead us to be suspicious of new models that claim to be more sophisticated and yield more precise values than prior iterations. The challenges for valuation research in the future lie in the types of companies that we are called upon to value. First, the shift of investments from developed markets to emerging markets in Asia and Latin America has forced us to re-examine the assumptions we make about value. In particular, the interrelationship between corporate governance and value, and the question of how best to deal with the political and economic risk endemic to emerging markets have emerged as key topics. Second, the entry of young companies into public markets, often well before they have established revenue and profit streams, requires us to turn our attention to estimation questions: How best do we estimate the revenues and margins for a firm that has an interesting product idea but no commercial products? How do we forecast the reinvestment needs and estimate discount rates for such a firm? Third, with both emerging market and young companies, we need to reassess our dependence on current financial statement values as the basis for valuation. For firms in transition, in markets that are themselves changing, we need to be able to allow for significant changes in fundamentals, be they risk parameters, debt ratios and growth rats, over time. In short, we need dynamic valuation models rather than the static ones that we offer as the default currently. Fourth, as the emphasis has shifted from growth to excess returns as the driver of value, the importance of tying corporate strategy to value has also increased. After all, corporate strategy is all about creating new barriers to entry and augmenting or preserving existing ones, and much work needs to be done at the intersection of strategy and valuation. Understanding why a company earns excess returns in the first place and why those excess returns may come under assault is a pre-requisite for good valuation. Finally, while the increase in computing power and easy access to statistical tools has opened the door to more sophisticated variations in valuation, it has also increased the potential for misuse of these tools. Research on how best to incorporate statistical tools into the conventional task of valuing a business is needed. In particular, is there a place for simulations in valuation and if so,
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what is it? How about scenario analysis or neural networks? The good news is that there is a great deal of interesting work left to be done in valuation. The bad news is that it will require a mix of interdisciplinary skills including accounting, corporate strategy, statistics and corporate finance for this research to have a significant impact.
2.1.3The Cost of Distress Survival, Truncation Risk and Valuation Aswath Damodaran: Stern School of Business:Traditional valuation techniques- both DCF and relative - short change the effects of financial distress on value. In most valuations, we ignore distress entirely and make implicit assumptions that are often unrealistic about the consequences of a firm being unable to meet its financial obligations. Even those valuations that purport to consider the effect of distress do so incompletely. In this paper, they begin by considering how distress is dealt with in traditional discounted cash flow models, and when these models value distress correctly. Then they look at ways in which they can incorporate the effects of distress into value in discounted cash flow models. At last they conclude by looking at the effect of distress on relative valuations, and ways of incorporating its effect into relative value. In both discounted cash flow and relative valuation, they implicitly assume that the firms that they are valuing are going concerns and that any financial distress that they are exposed to is temporary. After all, a significant chunk of value in every discounted cash flow valuation comes from the terminal value, usually well in the future.
In this paper, they will argue that they tend to over value firms such as these in traditional valuation models, largely because is difficult to capture fully the effect of such distress in the expected cash flows and the discount rate. The degree to which traditional valuation models miss value distressed firms will vary, depending upon the care with which expected cash flows are estimated, the ease with which these firms can access external capital market and the consequences of distress.
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In this paper, they will begin by looking at the underlying assumptions of discounted cash flow valuation. Distressed firms, i.e., firms with negative earnings that are exposed to substantial likelihood of failure, present a challenge to analysts valuing them because so much of conventional valuation is built on the presumption that firms are going concerns. In this paper, they have examined how both discounted cash flow and relative valuation deal (sometimes partially and sometimes not at all) with distress. With discounted cash flow valuation, they suggested four ways in which they can incorporate distress into value simulations that allow for the possibility that a firm will have to be liquidated, modified discounted cash flow models, where the expected cash flows and discount rates are adjusted to reflect the likelihood of default, separate valuations of the firm as a going concern and in distress and adjusted present value models. With relative valuation, they can adjust the multiples for distress or use other distressed firms as the comparable firms. at last this paper examine two issues that may come up when going from firm value to equity value. The first relates to the shifting debt load at these firms, as the terms of debt get renegotiated and debt sometimes becomes equity. The second comes from the option characteristics exhibited by equity, especially in firms with significant financial leverage and potential for bankruptcy.
2.1.4INTERNATIONALIZATION AND THE EVOLUTION OF CORPORATE VALUATION Ross Levine, Sergio L. Schmukler: This paper provides evidence on the bonding, segmentation, and market timing theories of internationalization by documenting the evolution of Tobin's .q. before, during, and after firms internationalize. Using new data on 9,096 firms across 74 countries over the period 1989-2000, they find that Tobin's .q. does not rise after internationalization, even relative to firms that do not internationalize. Instead, .q. rises significantly one year before internationalization and during the internationalization year. But, then .q. falls sharply in the year after internationalization, relinquishing the increases of the previous two years. To account for these dynamics, this paper
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shows that market capitalization rises one year before internationalization and remains high, while corporate assets increase during internationalization. The evidence supports models stressing that internationalization facilitates corporate expansion, but challenges models stressing that internationalization produces an enduring effect on .q. by bonding firms to a better corporate governance system. This paper examines the evolution of the corporate valuation of firms that cross-listed, issued depositary receipts, or raised equity capital in international markets over the period 1989-2000. This paper documents the time-series patterns of q before, during, and after internationalization and compares these patterns to firms that never internationalized and also examines the individual components of q in assessing what happens during the process of internationalization. The paper reports four key findings:First, international firms tend to have higher valuations than domestic firms. More specifically, the average q of firms that at some point in the sample internationalize is higher than the q of firms that never internationalize. Second, corporations do not experience an enduring increase in q after they internationalize. This paper finds that (a) valuations are not higher after internationalization and (b) valuations of firms that internationalize do not increase relative to those of domestic firms (i.e., the relative q does not increase after internationalization). Thus, although there are large cross firm differences in q, their results are consistent with the view that these differences are not affected by internationalization. Third, in terms of the year-by-year dynamics, q rises before internationalization, but then falls rapidly in the year after internationalization. They find that one year after internationalization the q of international firms is not significantly higher than it was two years (or even three years) before they internationalized. Furthermore, the relative Tobins q of international firms (q divided by the average q of domestic firms from the same home country) follows the same pattern: rising in the year before internationalization and during the internationalization year, but relinquishing these increases by the year after internationalization. Finally, in terms of the components of q, a firms market capitalization tends to rise prior to internationalization and remains high thereafter, while the firms assets increase during internationalization as the firm expands. Thus, firms that internationalize expand relative to domestic firms.
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RESEARCH METHOLODOGY
28 RESEARCH METHODOLOGY
The procedure of carrying out this research will be:
TYPE OF STUDY: DESCRIPTIVE RESEARCH:Descriptive research, also known as statistical research, describes data and characteristics about the population or phenomenon being studied. Descriptive research answers the
questions who, what, where, when and how. The description is used for frequencies, averages and other statistical calculations. Often the best approach, prior to writing descriptive research, is to conduct a survey investigation. Qualitative research often has the aim of description and researchers may follow-up with examinations of why the observations exist and what the implications of the findings are.
TYPE OF DATA: SECONDARY DATA

All methods of data collection can supply quantitative data (numbers, statistics or financial) or qualitative data (usually words or text). Quantitative data may often be presented in tabular or graphical form. Secondary data is data that has already been collected by someone else for a different purpose to yours. For example, this could mean using:

Data supplied by a marketing organization Annual company reports Government statistics.
SOURCES OF SECONDARY STUDY:

White Papers, Websites, Research Articles, Industry Reports.
SAMPLING PLAN: -Sampling size: 20

Sampling procedure: Judgment sampling
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TECHNIQUES OF ANALYSIS: Using statistical techniques and decision models.

Discounted Cash Flow approach PE multiplier model Dividend discount model Regression and correlation and Beta.
CHAPTER SCHEME
Chapter 1: Introduction Chapter 2: Research Design Chapter 3: Industry Profile Chapter 4: Data Analysis Chapter 5: Summary of Findings, Recommendations & Conclusion Chapter 6: Bibliography
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INDUSTRY ANALYSIS
31 1.1 OVERVIEW OF ECONOMY

India initiated the economic liberalization in 1991. The reforms did away with the License Raj (investment, industrial and import licensing) and ended many public monopolies, allowing automatic approval of foreign direct investment in many sectors. Since then, the overall direction of liberalization has remained the same, irrespective of the ruling party, although no party has tried to take on powerful lobbies such as the trade unions and farmers, or contentious issues such as reforming labour laws and reducing agricultural subsidies. Since 1991 India has emerged as one of the wealthiest economies in the developing world; during this period, the economy has grown constantly, but with a few major setbacks. This has been accompanied by increases in life expectancy, literacy rates and food security.
Table 1.1 Table showing the contribution of different sectors to GDP
Source: Economic survey 2007-08 The Indian economy which began with a bang clocking over nine percent in 2008 ended in none too comfortable position in the face of global recession resulting in slowdown of the domestic economy. But what is heartening is that India is not in the same bracket as other emerging economies because ours is largely domestic 37 market driven economy and that exports did not account for sizeable percentage of Indias Gross Domestic Product.
In early part of 2008 the stock market was surging with BSE Sensex, a barometer of the economy racing toward 21000 mark. The exports were surging growing at 20-30 per cent, which made Government fix an annual target of 200 billion dollars for 2008-09 for merchandise exports. Services exports raced towards an additional 100 billion dollars. Realty prices were
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booming and process were increasing on an average of 20%. Foreign exchange of reserves swelled week after weeks and it crossed 300 billion dollars. The Rupee was getting appreciated and at one point of time there were fears that Rupee-Dollar value may become 35 to a dollar. The oil prices swelled to up to 147 dollars a barrel commodity prices particularly metals were soaring.
The inflation skyrocketed and wholesale price index was in double digits for a number of months. On the back of over nine per cent growth for three years, the planners were evaluating the possibility of moving on the higher growth trajectory of 120% in the coming years. With signs of overheating of the economy, the monetary policy stance of Reserve Bank was hawkish with key short term rates leading to hardening of interest rates and CRR were increased periodically to suck out excess liquidity in a bid to tame the inflation. This picture changed after the middle of 2008 with the U.S subprime crisis resulting in slowdown the economy and then leading to financial turmoil that led to collapse of the banking system starting with Lehman brothers. This changed the global economic scenario and the world economy slipped into a recession as the year closed.
The entire economic scenario changed with U.S government announcing bailout package to banks and some leading industries as the crisis deepened and several 38 economies went on tailspin, global commodity prices started falling and oil prices nosedived from a high of 147 dollars to less than 40 dollars a barrel belying all expectation. The recession started with United States and spilled over to the European economies and then to several emerging economies.
Asian countries were no different. Japan and South Korea were hit hard and by the end of 2008, these economies too had slipped into recession. But India and China were different in the sense that despite visible signs of slowdown, the two Asian giants certainly had not slipped into recession. There might have been a dent on the growth story but certainly the two Asian giants remain to be the two fastest growing economies albeit at a reduced momentum. Unlike China India is better placed to deal with emerging economic situation in the New Year. With China
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being a global manufacturing hub, developed economies are increasingly depended on imports from the Asian giant. But with the industrialized nations facing the worst even recession since 1929 Chinas growth has plummeted in the last two quarters and is now placed around 5-6% in the face of falling exports. This was something unimaginable a few months back that too after Chinese economy clocked double-digit growth for over two decades. Indian is not that worse off as it is not an export driven economy. Goldman Sachs Investment Bank in its BRIC (Brazil, Russia, India & China) has argued that Brazil, Russia, India & China will be the superpower nations by 2050. BRIC report measures Indias potential as under. Baseline projections for Indias potential output growth show that the economy can sustain growth rates of about 8% until 2020, significantly higher than the 5.7% that projected in original BRICs paper. The key underlying assumption is that the government will continue to implement growth-supportive policies. The implications of this are that India will overtake the G6 economies before 2050. Indeed, Indias GDP (in US Dollar terms) will surpass that of the US before 2050, 39 making it the worlds second-largest economy. Indias contribution to world growth will also be high and increasing. Continued movement of labour and land from agriculture to other sectors, aided by continued openness to trade, financial deepening, investments in information and communication technology, and the building of highways is expected to be fuel the growth engine of India in coming years. Approach Paper of 11th Five year plan also given optimistic picture about Indian economys growth for the next five year period, prospects are as under, GDP will be around 9.00% Investments grow by 35.10% Agriculture growth rate expected to be doubled Creating of 7 Crore jobs Below poverty line below 10% of total population Increase flow of FDI.
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Once the current global downturn works its way through, the Indian economy should rebound, supported by a large, young workforce; gradual but consistent liberalization reforms; and a high rate of consumer and private-sector savings. The growing population and economic expansion will mean that India needs not just homes but offices, schools, hospitals, and entertainment centers. Addressing infrastructure needs is also an important priority to support this property market development.
Special Economic Zones can play an important role. On the investment side, the expected development of real estate investment trusts (REITs) in the future could expand the property investment opportunities available in India. There are, of course, many challenges that also face the sector in the coming years - skill shortages, limited good quality data, lack of low costaffordable housing, lack of sustainability, the need for clarity in taxes, planning codes, land registry, greater ease of transaction and professional standard for agents, amongst other things, will have to be addressed.
1.2 INDUSTRY ANALYSIS - IT AND ITES INTRODUCTION

Over the past decade, the Information Technology (IT) industry has become one of the fastest growing industries in India, propelled by exports (the industry accounted for more than a quarter of Indias services exports in 2005-06). The key segments that have contributed significantly (96 percent of total) to the industrys exports include Software and services (IT services) and IT enabled services (ITES) i.e. business services. Over a period of time, India has established itself as a preferred global sourcing base in these segments and they are expected to continue to fuel growth in the future. Information Technology Enabled Services (ITES) is a large, fast-growing worldwide industry fueled by customers seeking efficiency and cost-savings from outside vendors, as well as rapid advancements in telecommunications and information technology. Offshore outsourcing of these services has become accepted and prevalent. India has the potential to obtain a share of this
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market, which could result in a substantial number of jobs and meaningful export diversification for the country. The chief advantage of India in this market is low cost labor. However, the high costs of telecommunications clearly constrain the potential and profitability of companies in this sector, which is critically dependent on information transfer. The small domestic market for IT related services also limits training and experience of local workers in order to gain expertise in higher value-added ITES. The strategy must also be opportunistic, taking advantage of any openings in the market that present themselves. While there are promising segments in the market, firms must remain flexible in their focus. One of the advantages of a new market entrant is that they can react to market opportunities faster than firms already entrenched in the market.
DEFINITIONS
HARDWARE:
Hardware includes computing and networking hardware and peripherals. It does not include consumer electronics.
SOFTWARE AND IT SERVICES:

Software & IT Services includes packaged software, IT services and IT training services.
INFORMATION TECHNOLOGY (IT)

IT is The study, design, development, implementation, support or management of computerbased information systems, particularly software applications and computer hardware", as defined by the Information Technology Association of America (ITAA).
IT ENABLED SERVICES:
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IT Enabled Services (ITES) includes all business processes being outsourced or off-shored by companies facilitated by Internet, telecom and similar means.
EVOLUTION OF THE INDUSTRY IT EVOLUTION:

1. 1968: The Tata industrial conglomerate forms software services unit TCS. 2. Mid-1970s: IBM exits India. Import duties of 150 percent or more mean that VCRs cost $3,000 and TVs cost $6,000. Wipro starts to create India's first homegrown PC. 3. 1994: Telecom liberalized. 4. 1995: TCS determines that its Case Pac tool developed for IBM can be used to scans software for Y2K problems. An industry is born. 5. 1999: Y2K contracts pile into India. 6. 2000: Indian companies expand hiring. Massive layoffs in US 7. 2003: Led by service conglomerates such as Wipro and Infosys, India becomes a primary destination for offshore outsourcing as foreign companies seek to lower cost.
ITES EVOLUTION:
ITES evolution can be divided into four phases as follows 1. First phase of evolution: In the first phase of evolution of the ITES industry in India, many MNCs established captive units in India for customer support and transaction processing. General Electric Capital Services (now Genpact) was the first MNC to pioneer ITES in India when it opened an India-Based international call center in the year 1997 to perform tasks such as money collection, credit card servicing, and data management. Other multinationals followed, establishing their own captive wholly-owned offshore facilities. These included British Airways (World Network Services), HSBC, and Swissair. 2. Second phase of evolution: In the second phase of evolution, third party units were set up in India by MNCs (for outsourcing activities), non-resident Indians (NRIs), Indian independents, and Indian IT companies. Established software services such as Infosys, Wipro
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and Satyam ventured into the ITES business in 2002 by establishing subsidiaries. Quite a few of these third party start-ups were small ventures with 50-100 seats (workers), and they generally focused on low-skill, routine activities, competing primarily on the basis of cost. More developed IT outsourcing firms tended to move towards higher value-added products competing to a greater extent on specialized talent. 3. Third phase of evolution: The third phase of evolution of the ITES industry in India has been characterized by the increasing trend towards geographical dispersion of activities; mergers and acquisitions (M&As) have also taken place within the industry in this phase. Industry observers reported 574 M&As in 2003, and 353 in 2004. With this process, many smaller ITES companies found it difficult to survive, and the M&A activity has continued. Going forward, competing small and medium-sized firms with complementary skills are likely to merge their operations to compete with larger global firms. 4. Fourth phase of evolution: In the current and fourth phase of evolution of the ITES industry in India, there is an increasing trend towards Indian companies acquiring small to medium size businesses in overseas locations. These foreign acquisitions mark a contrast to the practice of foreign MNCs sitting up BPO units in India to take advantage of the lower costs here. Also, these acquisitions are probably in the nature of a market-entry strategy. There is also the growing trend of niche players in industry verticals or specific business processes setting up BPO businesses. Many of these players have had long experience in the domestic market and are now offering offshore BPO services.
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Graph 1.1: Global IT and ITES Industry
The global IT and ITES industry will account for US$ 2.33 trillion b 2006, growing at a CAGR of 7.7%. The IT industry's contribution to GDP rose from 1.2 per cent in 1999-2000 to an estimated 4.8 per cent in 2005-06. A majority of the companies in India have already aligned their internal processes and practices to international standards such as ISO, CMM, and Six Sigma. This has helped establish India as a credible sourcing destination. As of December, 2006, over 400 Indian companies have acquired quality certifications with 82 companies certified at SEI CMM Level 5 - higher than any other country in the world.
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Graph 1.2: Indian IT and ITES Industry The ITES and Software & IT services segments would drive the growth of Indian IT industry. Market size in 2002 was 15.788 billion US$, in 2006 it was 41.56 billion US$. When it comes to IT services, the world is coming to India. According to Nasscom, the Indian IT-ITES industry recorded US$ 39.6 billion in revenues in 2006-07, up 30.7 per cent against a projected growth of 27 per cent. The industry body has projected revenue of US$ 49-50 billion in 2007-08 at a growth rate of 24-27 per cent. Incidentally, the Indian IT industry is growing well ahead of the global industry, which is growing at about 10 per cent a year. The Indian ITES Export Industry has grown by about 44% in 2003-04 to US$3.6 billion and is expected to grow by 42 % in 2004-05 to touch US$5.1billion.
40 FACTORS AFFECTING THE IT INDUSTRY

Cost (cost of labor, infrastructure costs and currency exchange rates) Labor competitiveness (size of the available labor pool, level of education, domain skills, fluency in the English language, cultural compatibility to western markets and attrition rates); and Other factors, such as existing business and political risks associated with the country, geographic location (physical and time difference), tax regime, and regulatory considerations such as data security and intellectual property rights (IPR) issues.
The only way out is by way of overall economic growth. India over the last few years has shown good economic growth mainly because of IT and revival in manufacturing sector. The revival in manufacturing is coming because of increased spending in infrastructure by the government. A super power is not only recognized by its economic growth but also by its social growth. Hence if India has to become a super power it has to take its people together. It has to utilize its manpower to full potential. This is possible if India becomes the hub of global outsourcing. Outsourcing of not only ITES but also various other sectors like textile, auto ancillaries, biotechnology, clinical research, petrochemicals, etc. The SWOT analysis of the ITES sector and the strategy, which needs to be adopted by the Industry and the Government so that we grab a bigger pie in the global market so as to realize our ultimate dream of becoming a global super power is given below.
INDIAN IT EXPORT INDUSTRY

While Indian exports of Project oriented services grew by almost 18% in 2004 the worldwide market grew by 4.5%. Indian companies currently export software services and products to 112 countries around the world. 69% of the total IT exports revenue from USA. 185 of The Fortune 500 companies outsource IT services from India. Emerging markets for IT Exports include Japan, Singapore and Australia, Latin America, Eastern Europe
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Graph
INDIAN ITES EXPORT INDUSTRY INDUSTRY TRENDS

The following are some of the key trends observed in the Indian IT sector today. Offshore outsourcing is being actively embraced by not only large organizations but also middle market companies in the US Competition from Multi National IT services providers who are setting up offshore presence aggressively. The Build-Operate-Transfer (BOT) model appears to be gaining momentum Reverse brain drain with 000s of Indians returning to India after years of leadership roles in Silicon Valley start-ups and technology MNCs
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Cutting edge R&D work being done out of India over 1700 US patents filed in CY2003; Examples Texas Instruments (225 patents), Intel (125 patents), Philips (102 patents), Cisco (120 patents) India becoming APAC hub for many MNCs (SAP Labs, Nokia, ADI, Cisco); Besides, many Asia-Pacific companies leveraging India better (LG Soft, Samsung R&D, Sony R&D, DLink, Huawei)
ITES - SWOT ANALYSIS STRENGTHS:

1. Large English speaking population: India is a dominant player in off shoring thanks to its large English speaking population, talented workforce, and low wages. 2. Cheap labor cost: The cost of qualified personnel being lower in India than the western countries is attracting several offshore partners to make investments in India. India ranks high in areas such as qualifications, capabilities, quality of work, linguistic capabilities and work ethics. 3. Quick turnaround time: The time zone difference between India and US is used to advantage for providing quick turnaround time. India's unique geographic positioning makes this possible. While the US sleeps, India works. This effectively gives a 24 hr working environment. 4. Highly cost efficient as compared to Western countries: By outsourcing to India an organization can save as much as 40-50% percent of costs compared to what it would cost in the western countries thus allowing an organization a great competitive edge. 5. World Class Telecom Service: India administers one of the largest telecom networks in Asia with 24.3 million telephone lines expanding at more than 20% per annum and 123,000 route kilometers of fiber optic cable network. Over 8000 VSATs are installed all over the country by various service providers, private users and Government agencies. 6. Strong IT background Tertiary education: India produces largest number of graduates after China providing a huge talent pool for the industry.
43 WEAKNESSES:
1. Small players: Most of the Indian ITES companies have a few million dollar revenues which is very small as compared to global market. Hence clients are doubtful of their long-term sustainability and hesitate to give them large contract. 2. Irrational pricing: Small and desperate players are driving down the prices to grab the business causing irrational pricing behavior and are also failing to deliver. 3. High attrition: The attrition rate is as high as 60 %, this highly inflates the cost as the cost of training is about Rs 40,000 to Rs 60,000 per agent. 4. Margin: Due to a very strong competition from China and other Asian countries the profit margin has to be squeezed. 5. Infrastructure: Unreliable power supply necessitates creation of own backup thus adding to cost. India also suffers from paucity of bandwidth and time required to get a connection is large. 6. Weak Brand: Indian companies do not have a brand which is recognized globally e.g.-: Accenture, Ernst & Young are known for their BPO services.
OPPORTUNITIES:
1. Re-engineering process: Instead of performing only business transaction processing, higher value activity like re-engineering processes could present a unique opportunity. 2. Expanding to other sectors: India has a presence in customer interaction and financial accounting services. However Indias stake in data search, remote education, and network consulting which account for almost 50% of market is low. So these sectors present a great opportunity. 3. Unexplored markets: At present Indian ITES industry is focused on US. European Union and Japan still remain a big untapped market for India.
44 THREATS:
1. MNC stampede: Many large MNCs are opening their BPO offices in India to leverage cost advantage. It can hamper the growth of domestic companies. 2. Unable to Deliver: Due to small size and cut throat competition some companies might vanish failing to respect the contract, and thus marring the image of whole ITES industry. 3. Backlash in US & Europe: There is a rising misconception in developed nations that Indians are snatching away service jobs. So their governments are also pressurized to ban outsourcing which will hamper growth of ITES industry. 4. Low capacity utilization: Average capacity utilization is less (about 1.6), which affects the profitability of the company. 5. Newer entrants like China are introducing English in their curricula at large scale so within few years it will have a large English speaking population thus threatening us in non-voice business. 6. New technology: Any technological breakthrough can wipe out entire range of low-end jobs. e.g.-: Medical transcription was a thriving industry in India, but a voice based software which could prepare documents form voice completely wiped out the jobs.
SWOT ANALYSIS OF ITES INDUSTRY IN INDIA AND CHINA INDIA STRENGTHS:

1. Cost competitiveness 2. Large skilled labor pool 3. Superior service maturity 4. Government support 5. Good track record in IT
WEAKNESS:
1. Infrastructure
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2. Skilled manpower
OPPORTUNITIES:
1. Geographical diversification 2. Moving up the value chain 3. Lot of MNCs coming to India
THREATS:
1. Manpower shortage 2. Emerging low cost nations 3. Rising wage costs and attrition rates 4. Rupee Appreciation
CHINA STRENGTHS:
1. Superior infrastructure 2. Cost competitiveness 3. Large skilled labor pool 4. Government support
WEAKNESSES:
1. Low service maturity 2. Lack of English language capabilities 3. Weaker project management capabilities than India 4. Lack of good quality record in software 5. Limited ITES experience 6. Complicated legal structure, IPR problem, lack of standards
OPPORTUNITIES:
1. Penetration into Japanese and Asian markets
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2. Non-voice services
THREATS
1. 2. Emerging low cost nations Rising wage costs and attrition
STRATEGIES GOVERNMENT:
Private sector participation in Infrastructure: Although India is well known for its IT skills; still we suffer from paucity of bandwidth. Also demand for electricity always exceeds supply leading to power cuts. Hence government should encourage private sector participation to increase bandwidth and power supply. Input prices: Government should further reduce taxes and import duties on computer, networking hardware (optical fiber) to reduce input costs to ITES industry. Initiative through NASSCOM: Government should take an initiative in WTO to avoid any protectionist measures by developed nations e.g.-: Newly passed bill on outsourcing in US giving a preferential status to local companies, should be opposed on WTO platform.
INDUSTRY:
Brand building: NASSCOM should project India not only as a back office of the world but also a end to end solution provider creating a strong brand of Indian ITES Industry. Promote Indian BPO by lobbying in Senate: The industry, in collaboration with the CII, NASSCOM, should lobby in the U.S to educate their Union about the benefits of outsourcing & that loss of jobs is as low as only 1 %. Tap EU & Japanese Market: Industry can give training to its professionals in non-English languages to cater these markets. Tap intellectual capital: Indian ITES industry should look into expanding in new regions and leveraging local strengths for their advantage e.g.-: e-Daksh in Philippines for US GAAP accountants.
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Shift to small cities: Smaller cities have lower labor cost & attrition rate due to less aspiration. No poaching zone: The industry should come together to create a no poaching zone so as to discourage the high attrition rate.
GLOBAL COMPARISON
For the foreseeable future, India is expected to be the preferred destination for ITES services. Indias competitiveness on key parameters is expected to be maintained. However, Indias current share of 46% of the global ITES market may be challenged by a number of countries, most notably China, the Philippines, and Malaysia. These countries may compete in certain specific niches, e.g., the Philippines in call centers. While Eastern European countries may remain the leading outsourcing destination for Western European companies, China may remain the preferred supplier for Japanese companies. To further increase Indias share of the European market, National Association of Software and Services Companies (NASSCOM) has signed an agreement that could encourage and allow European small and medium enterprises (SMEs) to use outsourcing opportunities in India. Over the long term, China may become Indias principal competitor, while minor challenges may be posed by Russia, South Africa, and Eastern Europe. However, India is substantially ahead of China in terms of HR capabilities, basic technical skills, fluency in the English language, and comfort in dealing with English-speaking customers. As compared with China, Indias supply of qualified labour also seems set to increase over the next decades. Between 2005 and 2020, the supply of labour in India in the age group 20-34 years should increase by around 66 million people or some 4.4 million people next year. Indias population in the age group 2034 years is projected to exceed Chinas by the middle of the next decade
ECONOMIC TRENDS AND ITS IMPLICATIONS

As per NASSCOM STRATEGIC REVIEW 2007, the Indian IT-BPO sector (including the domestic and exports segments) is growing at an estimated 28 percent in FY2007. Total revenue aggregate for the sector is expected to exceed USD 47.8 billion, nearly a ten-fold increase over
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the aggregate revenue of USD 4.8 billion, reported in FY1998, and direct employment is likely to cross 1.6 million. As a proportion of national GDP, the revenue aggregate of the Indian technology sector has grown from 1.2 percent in FY1998 to an estimated 5.4 percent in FY2007. Net value-added by this sector, to the economy, is estimated at 33.5 percent for FY2007. Service and software exports remain the mainstay of the sector; FY07 export growth likely to beat forecasts and exceed 32 percent. While the US and the UK remain the dominant markets, contributing to 67 percent and 15 percent of total exports respectively, firms are also keenly exploring new geographies for business development, and to strengthen their global delivery footprint. Banking, Financial Services and Insurance, and Technology (Hi-tech/ telecom) are the main verticals, accounting for nearly 60 percent of the total. Manufacturing, Retail, Media, Utilities, Healthcare and Transportation follow also growing rapidly. Positive market indicators including large unaddressed white-spaces and the unbundling of IT-BPO mega-deals with increasing shares of global delivery, strongly support the optimism of the industry in achieving its aspired target of USD 60 billion in exports by 2010. India is uniquely advantaged to best address these opportunities. IT services exports, accounting for 55-57 percent of total exports, are growing at an estimated 36 percent and are expected to reach USD 18.1 billion in FY2007. Newer areas of application and infrastructure management, testing, etc. are gaining traction, with their share in the business-mix growing steadily. BPO continues to grow in scale and scope, with firms increasingly adopting a vertical focused approach. Total exports for this segment are expected to exceed USD 8.3 billion in FY 2006-07, growing by 32 percent over the previous year. Lastly, increasing traction in offshore product development and engineering services is supplementing Indias efforts in own IP creation. This group is growing at 22-23 % and is expected to report USD 4.9 billion in exports, in FY 200607. In 2006-07, software and services exports grew by 33 per cent to register revenue of US$ 31.4 billion, whereas the domestic segment grew by 23 per cent to US$ 8.2 billion. Within exports, IT
49
services touched US$ 18 billion, a growth of 35.5 per cent. TCS, Infosys and Wipro maintained their position as the Top 3 exporters in the Nasscom Top 20 IT software and services exporters rankings. The value of Infosys brand went up by 38 per cent to be worth US$ 7.68 billion in 2006-07. The global IT services business exceeds US$ 600 billion a year, while the Indian industry turnover is about US$ 31 billion. The Indian IT industry continues to be amongst the largest employers, directly employing more than 1.6 million and indirectly creating employment opportunities for an additional 6 million people in related industries. The industry contribution accounts for 5.2 per cent of the national GDP in India. Worldwide technology and related services spending crossed USD 1.5 trillion in 2006, growing at 7.7 percent over 2005. Healthy tech-sector performance was sustained by above forecast GDP growth across the key economies of Europe and the US, as well as in emerging markets. Outsourcing continued to be the primary growth engine with global delivery forming an integral part of most sourcing strategies. After the early enthusiasm about alternate sourcing locations, firms are reaffirming their preference for India, reflecting a maturing appreciation of its unique value-proposition. India based delivery continues to grow, driven by local firms reporting steady growth in large contract. Worldwide technology related spends are forecast to reach USD 2.1 trillion by 2010, growing at a CAGR of more than 7 percent over 2006-2010. Growth in global sourcing is expected to outpace growth in total spends, with up to USD 110-120 billion of the total amount spent on software and services in 2010, likely to be sourced through the global delivery model. Rapid evolution of technologies and Internet applications, and the rise of pervasive computing are expected to drive a rapid and quantum increase in technology adoption by businesses and individuals. The proliferation of client devices and end-user or end-use devices at the network edge will result in the addition of billions of devices to the network edge, which will drive the need for more enterprise systems to deploy, manage, and make use of them. The resultant increase in scale and complexity of ICT infrastructure and applications, will lead to an increased demand for skilled IT resources. The ageing demographics in most developed countries will necessitate an increasing reliance on globally dispersed talent pools to meet the demand for professionals contributing to accelerated growth of the global sourcing phenomenon.
50
Reputed external agencies have estimated the expected growth rates of IT spending (CAGR) over 2004-09 and market size by region, types of services, etc. Though the forecasts vary these agencies expect the IT industry to continue in its growth trajectory. The NASSCOM McKinsey Report 2005 estimates that the Indian IT industry has only addressed 10% of a potential market size in excess of US$ 300 billion so far. The report estimates that by 2010, of this US$ 300 billion opportunity, almost 35% or US$ 110 billion is expected to be relocated from source countries to low-cost offshore locations including India.
PROJECTED REVENUES ($ US BILLION) - 2008

India Based IT Services Software Products IT-enabled Service E-business Total 23 India Centric 7* Subtotal (International) 30 Domestic Total 1998
8.5
38.5
2.1
10
9.5
19.5
0.6
15
17
19
0.4
4 50
1 12
5 62
5 25
10 87
0.2 3.3
TABLE 1.1: PROJECTED REVENUES ($ US BILLION) - 2008
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DATA INTERPRETATION AND ANALYSIS

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1 EXECUTIVE SUMMARY

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1.2 OVERVIEW OF VALUATION

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1.3 THE ROLE OF VALUATION

1. VALUATION AND PORTFOLIO MANAGEMENT

2. VALUATION IN ACQUISITION ANALYSIS

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3. VALUATION IN CORPORATE FINANCE

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6 1.ADJUSTED BOOK VALUE APPROACH

2. STOCK AND DEBT APPROACH

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C. CROSS SECTIONAL VERSUS TIME SERIES COMPARISONS

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D. STANDARDIZED VALUES AND MULTIPLES

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2. BOOK VALUE OR REPLACEMENT VALUE MULTIPLES

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CATEGORIZING DISCOUNTED CASH FLOW MODELS

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TOTAL CASH FLOW VERSUS EXCESS CASH FLOW MODELS

FREE CASH FLOW TO EQUITY DISCOUNT MODELS

FREE CASH FLOWS TO EQUITY

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THE FREE CASHFLOW TO THE FIRM

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DIVIDEND DISCOUNT MODELS

THE GENERAL MODEL

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THE GORDON GROWTH MODEL

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2. FREE CASH FLOWS TO EQUITY:Value of high - growth business =

FREE CASH FLOWS TO FIRM

PARTICULARS SALES LESS:-COGS EBIT

AMOUNT XXX XXX XXX

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4. DIVIDEND DISCOUNT MODEL:-

THE GORDON GROWTH MODEL

VALUE OF STOCK = DPS1/ KE G

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5. PRICE EARNINGS RATIO (PE)

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OBJECTIVES OF THE STUDY

SCOPE OF THE STUDY

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TYPE OF DATA: SECONDARY DATA

Data supplied by a marketing organization Annual company reports Government statistics.

SOURCES OF SECONDARY STUDY:

SAMPLING PLAN: -Sampling size: 20

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TECHNIQUES OF ANALYSIS: Using statistical techniques and decision models.

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