VALUATION

Debenture/Bond Valuation
Equity Valuation
Valuing of Warrants/
Convertible

VALUATION OF DEBT INSTRUMENTS

A Bond or debenture has the following:

Face Value or par value

Coupon Rate
Maturity
Redemption Value
Market Value

Value or Price of a bond or debenture equals the

present value of all the future benefits that one
receives in course of holding it.
n

Interest i redemption value

Value

i
n
(1 k )
i 1 (1 k )
Interest: the amount of interest paid
K: required rate of return
Redemption value: the amount received on
maturity

ABC Ltd issues debentures of face value Rs.100 bearing a

coupon rate of 10% compounded annually. The debenture
matures at the end of four years. A year has passed since
the debenture were issued. If the debentures are redeemed
at a premium of Rs.5 to the face value at maturity then
compute the current price (k=10%) of the debenture.103.73
(a) If the required rate of interest for the above bond is 11%,
then at what price would one buy the debenture? 101.20
(b) If due to immediate fund requirement one has to sell
the debenture at Rs.99 then what is the yield at which the
buyer is buying from him?
Approximately 12%
(c ) If the company pays a makes semi-annual payments
103.71
then what would be the value of the debenture

CURRENT YIELD
Coupon interest amount divided by the current price

YIELD TO MATURITY
Is that rate which equates the present value to the discounted value of future
cash flows.

BOND VALUE THEOREMS

If a debenture of face value Rs.100 is issued at a coupon rate of
10% for a maturity of 5years is trading at the yield of 10%, then
what is the price of the debenture?

If yield on a debenture is equal to coupon rate then the va

of debenture is equal to its face value or par value.
If a debenture of face value Rs.100 is issued at a coupon rate of
10% for a maturity of 5years is trading at the yield of 12%, then
what is the price of the debenture?

If yield on a debenture is more than the coupon rate then t

of debenture is less than its face value or par value.

If a debenture of face value Rs.100 is issued at a coupon rate of

10% for a maturity of 5years is trading at the yield of 8%, then
what is the price of the debenture?

If yield on a debenture is less than the coupon rate then th

of debenture is more than its face value or par value.

If a debenture of face value Rs.100 is issued at a coupon rate of

10% for a maturity of 5years is trading at the yield of 12%, then
what is the price of the debenture now/end of first/second/third
/fourth/fifth year ?
PV of
principal

PV of Interest
now

92.75

36.05

56.7

after 1 yr

93.97

30.37

63.6

after 2 yr

95.22

24.02

71.2

after 3 yr

96.6

16.9

79.7

after 4 yr

98.23

8.93

89.3

after 5 yr

100

100

If the yield is greater than the coupon rate then the

discount on the debenture declines as the year to
maturity approaches.

APPROACHES TO EQUITY VALUATION

Dividend capitalization approach
Price to Earnings approach
Book Value approach
Liquidation Value Approach

DIVIDEND CAPITALIZATION MODEL

Single Period Valuation

D1
Pr ice1
Pr ice0

(1 k ) (1 k )
At what price should an investor be willing to invest in
the share if its price is expected to be Rs.106 at the
end of the year and the company is expected to declare
a dividend of Rs.4. Assuming the investor requires a
8% rate of return.
101.85

Multiple Period Valuation

With constant dividends

D
D
D
Pr ice0

...
1
2
n
(1 k ) (1 k )
(1 k )

With constant growth of dividends

D(1 g ) D(1 g )
D(1 g )
Pr ice0

...
1
2
n
(1 k )
(1 k )
(1 k )
2

Dividends till perpetuity

D(1 g ) D(1 g )
Pr ice0

........
1
2
(1 k )
(1 k )
2

D1

kg

ABC Ltd paid a dividend of Rs.2 last year. The annual

growth rate in dividend is expected to be 7% and the
company expects to pay the dividends till perpetuity.
Compute the price of the share if the required rate of return
is 10%.
71.33

Price to Earnings Approach

Denoted by P/E

Market Pr ice of Share

P/E
Earnings Per Share

BOOK VALUE APPROACH

= Net Worth/ Total outstanding equity Shares

A companys share is currently selling at Rs.60. The

company in the past paid a constant dividend of
Rs.1.50 per share, but is expected to grow at 10%
annually over a very long period. Should the share
be purchased if the required rate of return is 12%.

Rs.82.50

An investor is looking for a four year investment. The share of

skylark company is selling for Rs.75. They have plans to pay
dividend of Rs.7.50 per share at the end of first and second
years and Rs.9 and Rs.15 respectively at the end of third and
fourth years. If the required rate is 12% and the share price at
the end of fourth year is Rs.70, what is the value of the share?
Would it be a desirable investment?

Rs.73.10

ACC Ltd. Paid a dividend of Rs.5 in the current year. The

dividends are expected to grow by 15% for the next 5 years,
and then grow at a rate of 10% for next three years.
Thereafter the dividends would grow at a rate of 5%
annually. Compute the price of the share if the required rate
of return is 10%.
Rs.178.50

WARRANTS & CONVERTIBLE SECURITIES

A warrant gives one the right but not the obligation to buy
a security at the fixed price.

A convertible debenture is one which can be converted into

equity shares.
Dr. Reddy is facing a fund problem. It issues convertible
debentures face value Rs.100 at a coupon rate of 3%. The
debentures can be converted into 3 equity shares at the end
of three years. Each share is expected to be quoting at a
price of Rs.40. At what price should the debenture be bought
by any investor if his required rate of return is 10%? If the
investor is ready to buy at face value then at what yield is he
buying?
97.61
Approximately 9%

Mr. Bansi lal a finance manager at Taloons Ltd has been

asked to raise funds for the company. The fund would be
used to fund a project the returns from which would only
start coming by the end of four years. The company can
issue either 10% debentures, redeemable at a premium of
Rs5 to face value or zero coupon bonds at a discounted
price of Rs.70 redeemable at face value at the end of four
years. Which option should he choose?
11.03% for coupon debentures
9.3% for zero coupon debentures