Session 6: Equity Valuation Models 1. Market consensus is that Analog Elec Corporation has an ROE of 9%, beta of 1.

25 and plans to maintain indefinitely its plowback ratio of 2/3. Current years earnings were Rs.3 per share. Annual dividend was just paid. Consensus estimate for coming years market return is 14% and T-bills yield 6% return. a. Find the price at which Analog stock should sell b. Calculate the P/E ratio c. Calculate the present value of growth opportunities 2. The stock of Nogro Corp is currently selling at Rs.10 per share. EPS in current year is expected to be Rs.2. Company pays out 50% of its earnings each year as dividend. The rest is retained and invested in projects earning 20% return per year and this is expected to continue indefinitely. a. Assuming that current market price reflects the intrinsic value as computed using the DDM what rate of return is expected by stock investors? b. By how much does its value exceed what it would be if all earnings were paid as dividends and nothing were reinvested? c. If Nogro were to cut its dividend payout ratio to 25% what would happen to its stock price? What if Nogro eliminated the dividend?
3. Fastgrowth Ltd has just paid a dividend of Rs.15 per share. The dividend is

expected to grow at a rate of 25% per year for the next 3 years and then level off to 5% per year forever. The appropriate market capitalization rate for this company is 20% per year. Please compute: a. The intrinsic value of a share of Fastgrowth Ltd today b. If the current market price is equal to this intrinsic value, what is the current dividend yield and expected dividend yield for next year? c. What is the expected price of Fastgrowth Ltd shares 1 year from now? d. What is the expected capital gain based on the expected price 1 year from now? 4. Sameer is an equity analyst working for a large brokerage house. He has used the Capital Asset pricing Model (CAPM) and the two-stage dividend discount model (DDM) value the stock of Bharat Paints. He now wants to value the stock of SnowWhitePaints using the same models. The following data are available:

Bharat Paints Beta Market Price Intrinsic Value 1.35 Rs.81 Rs.108

SnowWhitePaints 1.15 Rs.96 ?

Risk-free rate is 4.50% and expected market return is 14.50%.

a. Calculate the required rate of return for SnowWhite Paints based on above

data b. Sameer estimates the EPS and dividend growth rates for SnowWhitePaints as 12% p.a. for the first 3 years and constant rate of 9% p.a. therafter. The Company recently declared dividend per share of Rs.5.50. What can be the intrinsic value of the Companys shares using this data and the 2-stage DDM? c. Which companys shares should Sameer recommend for purchase based on intrinsic value and market price? Why? Equity Valuation Models (Free Cash Flow to Equity Model)

1. Ajay Sharma is an analyst with Reliable Mutual Fund and is trying to value the stock of ABC Forge Ltd using the FCFE model. He believes that ABC Firges FCFE will grow at 27% for 2 years and 13% thereafter. Capital expenditure, depreciation and working capital are all expected to grow proportionately with FCFE. From the following data calculate: a. The amount of FCFE per share for the year 2008 b. The current value of a share of ABC Forge Ltd based on the 2-stage FCFE model Income Statement (Rs.Millions) Revenue Depreciation Other operating costs Income before tax Tax Net income Dividends Earnings per share 2007 474 20 368 86 26 60 18 0.714 2008 598 23 460 115 35 80 24 0.952

Dividends Per Share Outstanding shares (millions) Balance Sheet (Rs.Millions) Current assets Fixed Assets Total Assets Current liabilities Long-term Debt Total Liabilities Shareholders' Equity Total Liabilities and Equity Capital Expenditure Selected Financial Information Required rate of return on Equity Growth rate of Industry Industry P/E ratio

0.214 84

0.286 84

2007 201 474 675 57 0 57 618 675 34

2008 326 489 815 141 0 141 674 815 38

14% 13% 26

2. Savita is valuing the stock of Stronglite Metals using the FCFE model. Based on the following data calculate: a. Suatainable growth rate of Stronglite Metals based on 2008 beginning of the eyar balance sheet values b. Free Cash Flow to equity for the year 2008 c. If the normalized earnings per share of the Company is estimated at Rs.1.71, the earnings growth rate for the Company is estimated at 11% and the current share price is Rs.25, are the Companys shares overvalued or undervalued on a P/E-to-growth (PEG) basis using the normalized EPS compared to the industry as a whole? (Rs.Millio ns) 2008 13.00 30.00 209.06 252.06 474.47 (154.17) 320.30

Balance Sheet Cash Accounts receivable Inventory Current Assets Gross Fixed Assets Accumulated Deprn Net Fixed Assets

2007 5.87 27.00 189.06 221.93 409.47 (90.00) 319.47

Total Assets Accounts Payable Current Liabilities Long-term Debt Total Liabilities Share Capital Retained earnings Total Shareholders' equity Total Liabilities and Shareholders'Equity Income Statement (Rs.Million) Revenue Total Operating expenses Operating profit Gain on sale of fixed assets EBITDA Depreciation & Amortization EBIT Interest Tax Net Income Notes to Accounts for 2008

541.40 26.05 26.05 245.00 271.05 150.00 120.35 270.35 541.40 Y.e.200 8 300.80 -173.74 127.06 4.00 131.06 -71.17 59.89 -16.80 -12.93 30.16

572.36 25.05 25.05 240.00 265.05 160.00 147.31 307.31 572.36

Note 1: The Company had Rs.75 million in capital expenditure during the year Note 2: Machinery with original cost of Rs.10 million and book value of Rs.3 million was sold for rs.7 million. Machinery sales is an unusual item for the Company Note 3: Decrease in long-term debt represents an unscheduled principal repayment, there was no new borrowing for the year Note 4: On January 1, 2008, the company received cash by issuing 400,000 shares at a price of rs.25 per share Note 5: A revaluation of land during the year increased the estimated market value of land held for investment by Rs.2 million which was not recognized in the 2008 net profit. Company data for 2008 Dividends paid (Rs.million) Outstanding number of shares Dividend per share Earnings per share Beta

3.2 1600000 0 0.2 1.89 1.8

Industry & Market data Dec 31, 2008 Risk-free rate of return Expected return on market index Median Industry PE Expected Industry earnings growth rate

4.00% 9.00% 19.90 12.00%