VALUATION OFSECURITIES

Investment process invariability requires the valuation of securities in which the investments are proposed.
The value of a security may be compared with the price of the security to get an idea as to weather a
particular security is overpriced, under-priced or correctly priced. A number of concepts of valuation have
been used in the literature. Some of these are:

1. Book Value (BV). BV of an asset is an accounting concept based on the historical data given in the
balance sheet of the firm. BV of an asset may either be given in the balance sheet or can be
ascertained on the basis of figures contained in the balance sheet. For example, the BV of a debenture
is the face value itself and is stated in the balance sheet. The BV of an equity share can be ascertained
by dividing the net worth of the firm by the number of equity shares.

2. Market Value (MV). MV of an asset is defined as the price for which the asset can be sold. MV of a
financial asset refers to the price prevailing at the stock exchange. In case a security is not listed, then
its MV may not be available.

3. Going Concern Value (GV). GV refers to the value of the business as an operating, performing and
running business unit. This is the value which a prospective buyer of a business may be ready to pay.
GV is not necessarily the MV or BV of the entire asset taken together. GV may be less than or more
than the MV/BV of the total business. Rather, GV depends upon the ability to generate sales and profit
in future. If the GV is higher than the MV, then the difference between the two represents the synergies
of the combined assets.

4. Liquidation Value (LV). LV refers to the net difference between the realizable value of all assets and
the sum total of the external liabilities. This net difference belongs to the owners/shareholders and is
known a LV. The LV is a factor of realizable value of an asset and therefore, is uncertain. The LV may
be zero also and in such a case, the owners/shareholders do not get anything if the firm is dissolved.
5. Capitalized Value (CV). CV of a financial asset is defined as the sum of present value of cash flows
from an asset discounted at the required rate of return. In order to find out the CV, the future expected
benefits are discounted for time value of money. In the valuation of financial assets, the CV is most
relevant concept of valuation and has been used in this text.

Required Rate of Return. In order to find out the CV, what is required is the determination of the required
rate of return of the investor for the specific security being valued. This required rate of return is used as the
discount rate to find out the present value. The required rate of return refers to the yield which the investor
wants to earn by making investment. It is consisting of two elements the risk free rate of return and the risk
premium. These two elements have been presented in the figure below