Valuation of Equity Shares

The valuation of equity share is difficult for

a. The rate of dividend is not given and b. Unlike rate of interest or rate of dividend on preference share, which remain constant over the life of the security, the rate of dividend on equity share may vary over the years.

Valuation Equity Share

The Basic Valuation 1. Single period valuation

Po = Div1 + P1
1+Ke Po = present value of share Div1 = expected dividend at the end of year 1 P1 = Expected price of share at the end of year 1 Ke = the required rate of return on equity capitalization rate or discount rate. -An under-value share has a market price less than the share present value -An over-valued share has a market price higher than the shares present value.

Problems- Single period valuation

1. Mr. A is planning to buy an equity share, hold it for one year then sell it. The expected dividend at the end of year 1 is Rs. 8 and sale proceeds Rs. 160 after 1 year. Determine the value of the share to the investor assuming the discount rate is 12%. The share of premier limited will pay a dividend of Rs. 3 per share after a year. it is currently selling at Rs. 50, and is estimated that after a year the price will be Rs. 53. what is the present value of the price if the required rate of return is 10%? Should the share be bought? Also calculate the return on share if it is bought and sold after a year. The equity share of a company is currently selling at Rs. 80. it is expected that the company will pay a dividend of Rs. 4 at the end of one year and the share can be sold at a price of Rs. 88. calculate the return on share. Should an investor buy it, it his capitalization rate is 12%.

2.

3.

Multi-Period Valuation
4. An investor expects a dividend of Rs. 8 per share for each of 5 years and selling price of Rs. 120 at the end of 5 years. Calculate the present value of share if his required rate of return is 10%. Dividend Valuation Model A. No Growth Case 5. A company is presently paying a dividend of Rs. 9 per share and is expected not to deviate from this in future . Calculate the value of the share if the required rate of return is 15%. 6. A company is presently paying a dividend of Rs. 12per share and is expected not to deviate from this in future . Calculate the value of the share if the required rate of return is 12%.

Dividend Valuation Model

B. Constant Growth case 7. A company is expected to pay a dividend of Rs. 8 per share next year. The dividends are expected to grow perpetually at a rate of 10%. What is the value of its share if the required rate of return is 15%. 8. HKN ltd. Is expected to pay a dividend of Rs. 2 a year hence. The companys dividend is expected to grow at the rate of 6% per annum. Calculate the price of equity share today if required rate of return for this share is 14%. 9. Investors require a 12% rate of return on equity shares of a company. What would be the market price of the share if the previous dividend was Rs. 4 and the investors expected dividend to grow at a constant rate of 11%.

Dividend Valuation Model

10. The book value per share of a company is Rs. 145.50 and its rate of return on equity share is 10%. The company follows a dividend policy of 60% payout. What is the price of its share if the capitalization rate is 12%. 11. A firm had paid dividend at Rs. 2 per share for last year. The estimated growth of the dividends from the company is estimated to be 5% per annum. Determine the estimated market price of the equity share if the estimated growth rate of dividend (i) raises to 8% and (ii) falls to 3%. Also find out the present market price of the share given that rate of return of the equity investors is 15.5%.

Dividend Valuation Model

12. A firm had paid dividend at Rs. 2 per share for last year. The estimated growth of the dividends from the company is estimated to be 5% per annum. Determine the estimated market price of the equity share if the estimated growth rate of dividend (i) raises to 8% and (ii) falls to 3%. Also find out the present market price of the share given that rate of return of the equity investors is 15.5%.

Dividend Valuation Model

C. Supernormal Growth case (variable growth rate) 12. A company is expected to pay dividend of Rs. 5.60 next year. This amount of dividend likely to grow @ 7% P.A. for further three years and after that growth rate is likely to stabilize @ 3 %. If cost of capital is 12%,caliculate current market price of the share. 13. A company is currently paying a dividend of Rs. 4.24 per share. The dividend is expected to grow at a 18% annual rate for 5 years and than 12% forever. What is the present value of the share, if the capitalization rate is 14% ?

Dividend Valuation Model

14. A company is currently paying a dividend of Rs. 2.00 per share. The dividend is expected to grow at a 15% annual rate for 3 years, than 10% rate for the next 3 years after which it is expected to grow at 5% rate forever. What is the present value of the share if the capitalization rate is 9%.

Earnings Capitalization Model

When the earnings of the firm are stable or when there is an expansion situation, the value of an equity share can be determined by capitalization of earnings. The earnings of the firm will be stable if it neither retain any earnings nor employs any external financing. In such a situation, the retention rate, b is zero and the growth rate, br would also be zero because g=br. Further as there is no retention, dividends. D0 will be equal to earnings E0

Earnings Capitalization Method

15. Calculate the price of the share if EPS= Rs. 2.50, b= 0.4, Ke= 0.10 and ROE= r= 0.20. what shall be the price if r=Ke= 0.10. 16. Satya systems company has made net profit of Rs. 50 crore. It has announced to distribute 60% of net profit as dividend to share holders. It has 2 crore equity shares outstanding. The company shares currently selling at Rs. 240. in the past it had earned return on equity of 25% and expects to maintain this profitability in the future as well . What is the required rate of return on satyas share.

Value of Growth Opportunities

17. A company expects to pay a dividend of Rs. 7 next year that is expected to grow at 6 per cent . It retains 30% of earnings. Assume a capitalization rate of 10%. You are required to
a) Calculate the expected earnings per share next year (EPS). b) Return on equity (ROE). c) The value of the growth opportunities.

18. Rama Tours and Travels Ltd has current earnings per share of Rs. 8.60. which has been growing at 12%. The growth rate is expected to continue in future. Rama has a policy of paying 40% of its earnings as dividend. If its capitalization rate is 18%, what is value of the share? Also calculate value of growth opportunities.

Market price of share

19. A share of tension free economy ltd is currently quoted at a price earning ratio of 7.5 times. The retained earnings per share being 37.5 % is Rs. 3 per share. Compute
I. II. III. The companys cost of equity, if investors expect annual growth rate of 12%. If anticipated growth rate is 13% P.a. calculate the indicated market price, with same cost of capital. If the companys cost of capital is 18% and anticipated growth rate is 15% P.a. calculate the market price per share assuming other conditions remains the same.

20. A companys current price of share is Rs. 60 and dividend per share is Rs. 4 . If its capitalization rate is 12 per cent, what is the dividend growth rate?