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YTM of 5 year bond, paying 6% rate of interest on FV Rs. 1000 and currently selling for Rs. 883.40 is 10%
as shown below.
YTM= 11.3%
Bond Value and Amortization of
Principal
• A Bond (debenture) may be amortized every year
(the principal is repaid every year rather than at
maturity). The cash flow is uneven.
• CF is cash flow including both interest and
principal.
CF is cash flow including both interest and principal.
B) Pure Discount Bonds
Present value of irredeemable preference share with Rs. 100 as issued price, dividend
of Rs. 9. Current Yield is 11%.
Yield on Preference Share
• If price of Preference Share = Rs. 81.82 and
Dividend of Rs. 9, what is the current yield/return
to investors?
• 81.82 = 9/ Kp
• Kp = 0.11 or 11%
Valuation of Ordinary Shares
• The valuation of equity shares is relatively more
difficult due to two factors:
2. The rate of payment of dividend is unknown and
payment of dividend is discretionary. Cash flow
is uncertain.
3. Earnings & dividends on equity shares are
expected to grow.
g = (P1 – Po)/ Po
g is expected growth/capital gain.
For the aforesaid example, g = (21 – 20)/20 = 5%
Rearranging, P1 = Po(1 + g)
Multi – Period Valuation
• Po can be calculated by :
Thus, the general formula for a share is as follows:
If n approaches to infinity
GROWTH DIVIDENDS
• The expected dividends in practice could
increase, decrease or remain same. Due to
retention policies the earnings and dividends
of companies grows over time.
2. For example, if for the same company in case the b = 0, DIV = EPS
Po = Rs. 55.58
= Rs. 55.58
Thus, the difference between Rs. 100 and Rs. 55.58 is the value growth
opportunities. Retention of earnings adds value since it generates cash flow.
Price–Earnings Ratio (P/E Ratio)
• Price of a share divided by EPS = P/E Ratio and
its reciprocal is called earnings – price ratio or
earnings yield (E/P).
• Further, estimation of EPS may be meaningless
because of measurement problem of EPS.
• Earnings may include non – cash items like
depreciation.
• Thus it is difficult to interpret EPS meaningfully
and rely on P/E ratio as a measure of
performance.