EQUITY VALUATION (UNIT-3)

• In finance, valuation is a process of determining the fair market value

of an asset. Equity valuation therefore refers to the process of
determining the fair market value of equity securities.
BALANCE SHEET VALUATION
Concepts to be cleared
• The book value is the value of the asset as listed on the balance
sheet. The balance sheet lists assets at the historical cost, so the value
of assets may be higher or lower than market prices.
• In an economic environment with rising prices, the book value of
assets is lower than the market value.
• The liquidation value is the expected value of the asset once it has
been liquidated or sold, presumably at a loss to historical cost.
• Finally, the salvage value is the value given to an asset at the end of
its useful life; in other words, this is the scrap value.
What Is Book Value of Equity Per Share – BVPS?

• Book value of equity per share indicates a firm's net asset value (total
assets - total liabilities) on a per-share basis.
• When a stock is undervalued, it will have a higher book value per
share in relation to its current stock price in the market.
Liquidation value per share
• Liquidation value is the total worth of a company's physical assets if it
were to go out of business and its assets sold.
• Liquidation value is determined a company's assets such as real
estate, fixtures, equipment, and inventory. Intangible assets are
excluded from a company's liquidation value.
• Liquidation value is usually lower than book value, but greater than
salvage value.
• Assets are sold at a loss during liquidation because the seller must
gather as much cash as possible within a short period.
Replacement cost
• The use of this measure is based on the premises that market value of
a firm cannot deviate too much from its replacement cost.
• The ratio of market price to replacement cost is called Tobin q , after
James Tobin , a noble laureate in economics.
Single period valuation model
• Assuming a $ 5 dividend is expected after 1 year and the stock price is expected to be $ 20 after a year, the
value of the stock can be calculated assuming a discounting rate of 12% as follows:

• Value = D1/ (1+r) + P1/ (1+r)

• Where,
• D1 is the expected dividend after 1 year
• P1 is the expected price after 1 year of holding period
• r is the required rate of return (discounting rate)

• Value of the stock = $ 5 / (1.12) + $ 20 / (1.12)

• $ 4.46 + $ 17.86

• = $ 22.32
 What happens if the price of equity share is expected to grow at a rate
of g percent annually ?
Po = D1/r-g
The expected dividend per share of ABC company equity share is Rs
2.00. the dividend per share of ABC company grown over the past five
years at the rate of 5 percent per year. The growth rate will continue in
future . Furthermore market price of equity share is expected to grow at
the same rate. Find out the current price if required rate is 15 percent.

Po= 2.00/0.15-.05= 20
If expected rate of return is to be calculated
• R=D1/Po+g
• Expected dividend= 5
• Dividend expected to grow at 6 percent
• Current price of share = 5/50+0.06 =16 percent
Multi period Valuation model
• Constant growth model : Myron Gordon
• Po = D1/r-g
• XYZ company expected to grow at rate of 6 %.
• Dividend expected a year hence = 2.00
• Required rate of return is 14 %
• Po=2/0.14-0.06=25
Two stage Growth Model
H model
• In H model, the growth rate in the first phase is not constant but
reduces gradually to approach the constant growth rate in the second
stage.
• In the two-stage model, it is assumed that the first stage goes through
an extraordinary growth phase while the second stage goes through a
constant growth phase.
Formula for H model
• Po=Do[(1+gn)+H(ga-gn)]
r-gn
• Ex: -
• The current dividend on an equity share of International Computers Limited is Rs
3.00. the present growth rate is 50 percent. However, this will decline linearly
over a period of 10 years and then stabilise at 12 percent. What is the intrinsic
value per share of International Computers Limited, if investors require a return
of 16 percent?
• The inputs required for applying the H-model are:
• D0 = Rs 3.00
• ga = 50 percent
• H = 10/2 =5 years
• gn = 12 percent
• r = 16 percent