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Chapter 3: Valuation of Bonds and Shares

Problem 1
(1) 1-year government bond maturity value (Rs)
Market rate of interest
PV of the bond: 1,000/1.08 (Rs)
(2) Purchase price of bond (Rs)
Implied return: (1,000 904.98)/904.98

1,000
8%
925.93
904.98
10.50%

Problem 2
Perpetual interest (Rs)
Current yield
Price of bond (B) (Rs): 140/0.13
Required rate
New price of bond (B) (Rs) : 140/0.15

140
0.13
1076.92
0.15
933.33

Problem 3
Face value (Rs)
Annual interest (Rs)
Maturity (years)
Maturity value (Rs)
Required rate
PVAF, 10 year
PVF, 10 year
PV of interest (Rs)
PV of maturity value (Rs): (d x g)
PV of 10-year debenture (Rs)

1000
140
10
1000
0.12
5.6502
0.3220
791.03
321.97
1113.00
n=10

0.14
5.2161
0.2697
730.26
269.74
1000.00

0.16
4.8332
0.2267
676.65
226.68
903.34

140t

1, 000
+
( 1 . 12)10
t =1 (1 . 12 )
140 PVAF. 12, 10 + 1, 000 PVF. 12, 10
1405 . 6502 +1, 000 0 .3220=Rs 1,113 . 00
PV of 10-year bond=

Similar calculations can be made if the required rate is 14% or 16%.


What would happen to the present value of bond if it had a maturity of 5 years? A similar procedure can be
followed. PV of a 5-year bond at 12%, 14% and 16% respectively will be as shown below:
Required rate
PVAF, 5 year
PVF, 5 year
PV of interest (Rs)
PV of maturity value (Rs)
PV of 5-year debenture (Rs)

0.12
3.6048
0.5674
504.67
567.43
1072.10

0.14
3.4331
0.5194
480.63
519.37
1000.00

0.16
3.2743
0.4761
458.40
476.11
934.51

1000
0.16
160
800

1300

1000

0.20

0.123

0.16

Problem 4
Face value (Rs)
Interest rate
Interest (Rs): (1,000 x 0.16)
Price of bond, B0 (Rs)
Yield =

Problem 5

INT
B0

Taxco (three-year maturity):

PVF

PVF

Year Cash flow


1
120
2
120
3
1120

9% PV (Rs)
0.917
110.09
0.842
101.00
0.772
864.85
1075.94

12%
0.893
0.797
0.712

Year Cash flow


1
60
2
60
3
1060

PVF 9% PV (Rs)
0.917
55.05
0.842
50.50
0.772
818.51
924.06

PVF 12%
0.893
0.797
0.712

Year Cash flow


1
120
2
120
3
120
4
120
5
120
6
120
7
120
8
1120

9% PV (Rs)
0.917
110.09
0.842
101.00
0.772
92.66
0.708
85.01
0.650
77.99
0.596
71.55
0.547
65.64
0.502
562.09
1166.04

12%
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404

Year Cash flow


1
60
2
60
3
60
4
60
5
60
6
60
7
60
8
1060

PVF 9% PV (Rs)
0.917
55.05
0.842
50.50
0.772
46.33
0.708
42.51
0.650
39.00
0.596
35.78
0.547
32.82
0.502
531.98
833.96

PVF 12%
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404

Maxco (three-year maturity):

Taxco (eight-year maturity):

Maxco (eight-year maturity):

Problem 6
(1) Annual compounding: Annual interest rate 12%
Discount rate - annual

10%
Period Cash flow
PVF
1 to 5*
120
5
1,000

* Annuity factor
(2) Half-yearly compounding: Half-yearly interest rate 6%
Discount rate -half-yearly
Period
Cash flow
PVF
1 to 10*
60
10
1,000

12%
PV

3.791
0.621

PVF
454.89
620.92
620.92

3.605
0.567

5%

6%
PV

7.722
0.614

PVF
463.30
613.91
1,077.22

7.360
0.558

* Annuity factor
(3) Quarterly compounding: Quarterly interest rate 3%
Discount rate -half-yearly

2.50%

3%

Period

Cash flow
1 to 20
20

PVF
60
1,000

PV

PVF

15.589
0.610

935.35
610.27
1,545.62

14.877
0.554

Bond 2
14%
13%
15
100
7.00%
6.50%
30
13.0587
7
91.41
0.1512
15.12
106.53
100
14.00%
7.00%

Bond 3
12%
8%
20
100
6.00%
4.00%
40
19.7928
6
118.76
0.2083
20.83
139.59
110
10.76%
5.39%

Bond 4
12%
8%
10
100
6.00%
4.00%
20
13.5903
6
81.54
0.4564
45.64
127.18
115
9.60%
4.82%

* Annuity factor
Problem 7
Face value (Rs)
Maturity periods (half-yearly)
Half-yearly interest rate
Interest payment period
Maturity value (Rs)
Required rate (half-yearly)
Interest payment, 11 to 20 years (Rs)
Value of interest (Rs)
Value of maturity value (Rs)
Value of bond (Rs)
20

1,000
20
6%
10
1,050
7%
60.00
214.23
271.34
485.57

60 t

1,050
( 1. 07 )n
t =11 (1 . 07 )
60( PVAF20 , 7 PVAF10 , 7 ) +1, 050PVF 20 , 7
Value of bond=

60 ( 10. 59407 . 0236 ) +1, 0500 .2584=Rs 485 . 57


Problem 8

Interest rate
Required rate of return
Maturity period (years)
Par/maturity value (Rs)
Semi-annual interest rate
Required rate of return (half-yearly)
Compounding periods
PVAF (annuity)
Half-yearly interest (Rs)
PV of interest (Rs)
PVF (lump sum)
PV of maturity value (Rs)
Bond value (Rs)
Current market price of bonds (Rs)
Annual yields (by trial & error)
Semi-annual yield (by trial & error)

Bond 1
16%
15%
25
100
8.00%
7.50%
50
12.9748
8
103.80
0.0269
2.69
106.49
95
16.86%
8.43%

Value of a bond that pays interest half-yearly can be calculated by the following equation:
2n

B 0 =
t =1

Problem 9

1
2

( INT t )

( 1+

kd

Bn
k
( 1+ d )2 n
2

20 year bond redeemable in 12 years: Half-yearly interest 5%; periods 24


24
50
1, 150
1, 000= t
+
t
(1+YTC )n
t=1 ( 1+YTC )
YTC=5 . 32
24
50
1, 100
1, 000= t
+
t
(1+YTC )n
t=1 ( 1+YTC )
YTC=5 . 22
20 year bond redeemable in 8 years: Half-yearly interest 5%; periods 16
16
50t
1, 150
1, 000=
+
t
(1+YTC )n
t=1 ( 1+YTC )
YTC=5 . 60

Problem 10

20 year bond redeemable in 12 years: Half-yearly interest 5%; periods 24


24
50t
1, 150
1, 000=
+
t
n
t=1 (1+YTC) (1+YTC )
YTC=5 .32
24
50
1, 100
1, 000= t
+
t
n
t=1 (1+YTC) (1+YTC )
YTC=5 .22
20 year bond redeemable in 8 years: Half-yearly interest 5%; periods 16
16
50
1, 150
1, 000= t
+
t
n
t=1 (1+YTC) (1+YTC )
YTC=5 .60
Problem 11
Annual interest rate
15%
Quarterly interest rate
3.75%
Market price (Rs)
875
Maturity value (Rs)
1000
Quarterly periods
60
New interest rate
12.00%
New quarterly interest rate
3.00%
Stated yield
Quarterly interest (Rs)
37.5
Market price (Rs)
875
Quarterly yield
4.34%
Expected yield
Quarterly interest (Rs)
30
Market price (Rs)
875
Quarterly yield
3.50%
Quarterly yields can be found by trial and error. You can also use the Excel formula for rate to calculate yield:
= RATE(nper,pmt,pv,[fv],[type],guess)
Problem 12
Value of perpetual preference share =12/0.10 = Rs 120

120

Value of redeemable preference share=


t =1

12 t
t

( 1. 10 )

110
( 1. 10 )7

12 PVAF7, 10 +110 PVF 7, 10


12 4 . 868+1100 . 513= Rs 114 . 87
You can use the Excel formula to calculate value of redeemable preference share: =PV(rate,nper,pmt,[fv],[type])
Problem 13
Expected DPS (Rs)
Current share price (Rs)
Share price after 1 year (Rs)
Required rate
PV of share (Rs):

P=

3.00
50.00
53.00
0.10

DIV 1 + P 1
( 1 + k e )1

3+53
1 .1

50.91

Return on share:

r e=

DIV 1 + ( P1P 0 ) 3+5350


=
=
P0
50

12%

Problem 14
Share price (Rs)
Capitalisation rate

75.00
0.12
Year
0
1
2
3
4
4

DPS
(Rs)

Share price (Rs)

7.50
7.50
9.00
15.00
70.00

Value of the share


It is a desirable investment since the present value of the share is more than its current price.

Problem 15
Current share price
DPS
Growth rate
Required rate
Value of the share:

60.00
1.50
0.10
0.12

PVF
at 12%
0.8929
0.7972
0.7118
0.6355
0.6355

PV
(Rs)
6.70
5.98
6.41
9.53
44.49
73.10

DIV 1
ke g
1. 5( 1 .1 )
1 . 65

=
=82 . 50
0 .12 0 . 10
0. 02
P0 =

82.5

Share should be bought


Problem 16
Earnings growth up to 7 years
Perpetual growth after 7 years
Required rate for 7 years
Required rate after 7 years
EPS
DPS

0.15
0.09
0.12
0.10
4.00
2.00
DPS
(Rs)

Year
0
1
2
3
4
5
6
7

PVF
@ 12%
2.00
2.30
2.65
3.04
3.50
4.02
4.63
5.32

0.8929
0.7972
0.7118
0.6355
0.5674
0.5066
0.4523

PV
(Rs)
2.05
2.11
2.17
2.22
2.28
2.34
2.41
15.58

Present value of dividend growing perpetually after 7 years

P7 =

DIV 7 ( 1+ g n ) 5 . 32(1. 09 )
=
=Rs 579 . 88
k e g n
0. 100 . 09

PV of Rs 579.88

579.88

579.88/1.10 =579.880.5132=Rs 297.57

Value of share: 15.58 + 297.57


Problem 17

(Rs)
Current EPS
Retention ratio, b
Current DPS, DIV0 = EPS0(1 - b)
Rate of return, r
Required rate, ke
Current share price (Rs)
Growth, g = b x r
Expected EPS (Rs): EPS1 = EPS0(1+g) = 5 x 1.09
Expected DPS (Rs): DIV1 = DIV0(1+g) = 2 x 1.09
Expected retained earnings, RE1 = EPS1 - DIV1
Value of share if g = 0

P0 =

EPS 1
5 . 45
=
k e g
0 . 13 0

5
0.6
2
0.15
0.13
60
0.09
5.45
2.18
3.27

41.92

Value of share if g = 9%

P0 =

DIV 1
k e g

2(1+. 09 )
2 .18
=
0. 13. 09 0 .04

Value of growth opportunities, Vg (Rs): 54.50 - 41.92

54.50
12.58

297.57
313.16

The following formula can be used to find Vg:

V g=

RE 1 ( rk e )
k e ( k eg )

3 .27 ( . 15. 13 ) . 0654


=
. 0052
. 13 ( . 13. 09 )

12.58

Problem 18
Total assets (Rs)
Equity (Rs)
Number of shares
Equity per share: 80,000/10,000
Internal rate of return, r
Earnings: 10% 80,000
EPS
Capitalisation rate, k
Retention ratio, b
Dividend per share, DIV: 30% 8
Growth rate, g: b r
Expected DIV: 0.240 1.07
PV of share: 0.2568/(0.12 0.07)

80,000
80,000
10,000
8
10%
8000
0.8
12%
70%
0.24
7%
0.2568
5.14

Problem 19
Last year's DPS (Rs)
Current market price (Rs)
Required rate

Growth rate
Value of share (Rs)

3
80
0.1
Scenario 1:
Scenario 2:
No growth
Perpetual growth

Scenario 3:
Different
growth rates

0
0.06
3/.10= Rs 30 3(1.06)/.1 - .06 =Rs Rs 68.84
79.5
(see below)

Scenario 3: Different growth rates


Growth rate
1-3 years
4-6 years
7 year and onwards

0.12
0.07
0.04

PV of DPS at 10% from year 1 to 6


PV of DPS growing perpetually at the end of 6 years:
5.16(1.04)/(.1 - .04)
PV of value of Rs 89.50 received at the end of 6th year:
89.5 x 0.5645

DPS (Rs)
3.00
3.36
3.76
4.21
4.51
4.83
5.16

PVF
0.9091
0.8264
0.7513
0.6830
0.6209
0.5645

5.37

16.6667
0.5645

Value of share (Rs): 18.32 + 50.42

Problem 20
Current DPS (Rs)
Current growth rate
New growth
Capitalisation rate
Share price (Rs) if g = 5%, [5(1.05)/(0.15-.05)]

Year
0
1
2
3
4
5
6

5
0.05
0.1
0.15
52.5

Share price (Rs) if g = 10%, [5(1.1)/(0.15-0.1)]

110

When the firms growth increases from 5% to 10%, the share prices rises from Rs 52.50 to Rs 110. It is quite
logical since price depends on expected dividend and future growth opportunities.
Problem 21
Face value (Rs)

10
EPS (Rs)

Bajaj
Hero Honda
Kinetic
Maharashtra. Scooters

Dividend rate

11.9
10.2
12.0
20.1

0.50
0.22
0.25
0.25

Market price
(Rs)
275.0
135.0
177.5
205.0

DPS (Rs)
5.0
2.2
2.5
2.5

Bajaj has the highest current share price but it also pays maximum dividend (as a percentage of its earnings). On the other hand, Maharashtra Scooters
EPS, lowest payout, lowest dividend yield and it is ranked third in terms of share price. Hero Honda has lowest EPS and lowest share price. Kinetic ra
in terms of EPS, DPS and share price. It appears that the market is giving consideration to the companies current performance as well as future growth
Problem 22
DPS in year 0 (Rs)
DPS in year 10, (Rs)
Period (years)
Dividend growth rate: [(10.5/3.5)1/10 -1]

3.5
10.5
10
0.1161

Share price (Rs)


Expected dividend yield [3.5(1.1161)/75]
Capitalisation rate: 0.1161 + 0.0521

75
0.0521
0.1682

Problem 23
Current EPS (Rs)
Growth
Payout
Retention ratio: 1 - .4
Capitalisation rate
DPS (Rs)
Expected EPS: 8.6 1.12
Expected dividend: 3.44 1.12
Expected retained earnings: 9.63 x 0.60
Share value (12% growth) (Rs)
Share value (no growth) (Rs)
Value of growth opportunities:
Firm's rate of return:

g= rb
r= g / b=. 12/ . 6
Value of growth opportunities:
V g=

RE 1 ( rk e )
k e ( k eg )

8.6
0.12
0.4
0.6
0.18
3.44
9.63
3.85
5.78
64.21
53.51
10.70
0.20

10.70

5 .78 ( . 20.18 ) .1156


=
. 0108
. 18 ( . 18. 12 )

Problem 24

Face value (Rs)

12%
debenture
1000

14%
debenture

Pref.
share
1000

100

Equity
share
100

Interest or dividend rate


Payment frequency
Maturity (years)
Compounding periods
Maturity value (Rs)
Principal amount (Rs crore)
Required rate of return
PVAF (annuity)
PVF (lump sum)
Interest/dividend amount (Rs)
Perpetual growth rate
Market value of each debenture or share (Rs)

Total market value (Rs crore)

12%
annual
12
12
1000
50
0.100
6.8137
0.3186
120

50
2
25
25%
12%
60%
40%
15
10%
16.5
240
6.88%
16.88%

Problem 26
Net earnings (Rs million)
Paid-up capital (Rs million)
Par value of share (Rs)
Number of shares: paid-up capital/par value of share
(mn.)

25
200
10
20

EPS = dividend per share, DIV (assumed): 25/20


Growth (without investment)
Opportunity cost of capital
Share price: P0 = (1.25 1.02)/ (0.10 0.02)
Investment (Rs million)
Earnings from investment (Rs million)
Life of investment, years
Investments NPV: PV of Rs 2 million for 15 years at
10%: 2*7.6061-10

1.25
2%
10%
15.94
10
2
15

Share price (with investment): 15.94 + 5.21 (million)

21.15

5.21

Problem 27
Earnings (without project) (Rs crore)
Number of shares (crore)
EPS: 80/5
Required rate of return
Share price (without project): 16/0.125

15%
annual annual

100
0.135

200
0.150

15

12
0.08

120 x 6.8137
70 x 11.4699
+ 1000 x .3186
+ 1000 x .3118 15/.135
12/(.15 - .08)
1136.27
1114.70
111.11
171.43
56.81
33.44
111.11
342.86

Problem 25
Net profit (Rs crore)
Number of shares (crore)
EPS: 50/2
ROE
Capitalisation rate, k
Payout
Retention ratio, b
Dividend per share, DIV: 60% 25
Growth rate, g: b r: 40% 25%
Expected DIV: 25 1.10
Current share price (Rs), P0
Expected dividend yield: DIV1/ P0
Capitalisation rate, k = (DIV1/ P0) + g

14%
half-yearly
10
20
1000
30
0.060
11.4699
0.3118
70

80
5
16
12.50%
128

Earnings from project after one year (Rs crore)


EPS from project: 20/5
Growth in earnings from project after one year
Required rate of return
Value of growth opportunities: 4/(0.125 0.08)
Share value with project: 128 + 88.89
EPS after project
P/E ratio: 216.89/20

20
4
8%
12.50%
88.89
216.89
20
10.84

Problem 28
Number of shares (million)
Net cash profits (Rs million)
Cash EPS: 80/10
Opportunity cost of capital
(a) (i) Retention ratio
Return on retained earnings
Growth: 40% 20%
Expected Dividend per share, DIV1: 8 (1 0.40) 1.08
Share price: 5.18/(0.20 0.08)
(a) (ii) Retention ratio
Return on retained earnings
Growth: 60% 20%
Expected Dividend per share, DIV1: 8 (1 0.60) 1.12
Share price: 3.58/(0.20 0.12)
(b) (i) Retention ratio
Return on retained earnings
Growth: 40% 24%
Expected Dividend per share, DIV1: 8 (1 0.40) 1.096
Share price: 5.26/(0.20 0.096)
(b) (ii) Retention ratio
Return on retained earnings
Growth: 60% 24%
Expected Dividend per share, DIV1: 8 (1 0.60) 1.144
Share price: 3.66/(0.20 0.144)

10
80
8
20%
40%
20%
8%
5.18
43.20
60%
20%
12%
3.58
44.80
40%
24%
9.60%
5.26
50.58
60%
24%
14.40%
3.66
65.37

Problem 29
Year
Cash EPS (perpetuity)
Payout
DIV
Opportunity cost of capital
(a) Share price: 10/0.15
(b) Expansion opportunity
Earnings retention
Rate of return
Growth: 50% 18%
DIV1: 5 1.09
Period of growth, years
Value of growth opportunity:

10
100%
10
15%
66.67
50%
18%
9%
5.45
10

0
1
2
3
4
5
6
7
8
9
10

EPS
10.00
10.90
11.88
12.95
14.12
15.39
16.77
18.28
19.93
21.72
23.67

DPS
5.00
5.45
5.94
6.48
7.06
7.69
8.39
9.14
9.96
10.86
11.84

V =DIV 1
5. 45

{ ( ) }]
{ ( ) }]

1
1+ g
1
kg
1+ k

1
1 . 09
1
0 .150 . 09
1 . 15

10

37.68

5. 4516 . 670 . 4148=Rs 37 . 68

Value after growth opportunity: (101.0910/0.15)


PV after growth opportunity: 157.80 1/1.15

10

Total share price with growth opportunity: 37.68 + 39.01

157.80
39.01
76.69

PVF
PV (Rs)
107.14
95.66
797.19
1000.00

6% PV (Rs)
0.943
113.21
0.890
106.80
0.840
940.37
1160.38

PV (Rs)
53.57
47.83
754.49
855.89

PVF 6% PV (Rs)
0.943
56.60
0.890
53.40
0.840
890.00
1000.00

PV (Rs)
107.14
95.66
85.41
76.26
68.09
60.80
54.28
452.35
1000.00

6% PV (Rs)
0.943
113.21
0.890
106.80
0.840
100.75
0.792
95.05
0.747
89.67
0.705
84.60
0.665
79.81
0.627
702.70
1372.59

PV (Rs)
53.57
47.83
42.71
38.13
34.05
30.40
27.14
428.12
701.94

PVF 6% PV (Rs)
0.943
56.60
0.890
53.40
0.840
50.38
0.792
47.53
0.747
44.84
0.705
42.30
0.665
39.90
0.627
665.06
1000.00

16%
PV

PVF
432.57
567.43
1000.00

PV
3.274
0.476

392.92
476.11
869.03

8%
PV

PVF
441.61
558.39
1,000.00

PV
6.710
0.463

4%

402.60
463.19
865.80

PV
892.65
553.68
1,446.32

PVF
PV
13.590
815.42
0.456
456.39
1,271.81

1-year bond
(i) Annual yield
10+100
95=
=15
1+ y
(ii) Half-yearly yield
5
5+100
95=
+
=7 . 8
1+ y (1+ y )2
2 year bond
(i) Annual yield
10 10+100
100=
+
=1
1+ y (1+ y)2
(ii) Half-yearly yield
5
5
5
100=
+
+
2
1+ y (1+ y) (1
3 year bond
(i) Annual yield
10 10
10
110=
+
+
2
1+ y (1+ y) (1
(ii) Half-yearly yield
5
5
5
110=
+
+
1+ y (1+ y)2 (1
4 year bond
(i) Annual yield
10 10
10

5
5
5
+
+
2
1+ y (1+ y) (1
3 year bond
(i) Annual yield
10 10
10
110=
+
+
2
1+ y (1+ y) (1
(ii) Half-yearly yield
5
5
5
110=
+
+
1+ y (1+ y)2 (1
4 year bond
(i) Annual yield
10 10
10
115=
+
+
1+ y (1+ y)2 (1
(ii) Half-yearly yield
5
5
5
115=
+
+
1+ y (1+ y)2 (1
100=

114.87

PV (Rs)
3.05
3.11
3.17
3.08
3.00
2.91
18.32
89.50
50.52
68.84

Payout
0.420
0.216
0.208
0.124

Earnings
yield
0.0433
0.0756
0.0676
0.0980

Dividend
yield
0.0182
0.0163
0.0141
0.0122

the other hand, Maharashtra Scooters has maximum


EPS and lowest share price. Kinetic ranks at third place
nt performance as well as future growth prospects.

12/(.15 - .08)

1-year bond
(i) Annual yield
10+100
95=
=15
1+ y
(ii) Half-yearly yield
5
5+100
95=
+
=7 . 8
1+ y (1+ y )2
2 year bond
(i) Annual yield
10 10+100
100=
+
=10
1+ y (1+ y)2
(ii) Half-yearly yield
5
5
5
5+100
100=
+
+
+
=5
2
3
1+ y (1+ y) (1+ y) (1+ y) 4
3 year bond
(i) Annual yield
10 10
10+100
110=
+
+
=6 . 24
2
1+ y (1+ y) (1+ y)3
(ii) Half-yearly yield
5
5
5
5
5
5+100
110=
+
+
+
+
+
=3 . 15
1+ y (1+ y)2 (1+ y)3 (1+ y )4 (1+ y )5 (1+ y)6
4 year bond
(i) Annual yield
10 10
10
10+100

5
5
5
5+100
+
+
+
=5
2
3
1+ y (1+ y) (1+ y) (1+ y) 4
3 year bond
(i) Annual yield
10 10
10+100
110=
+
+
=6 . 24
2
1+ y (1+ y) (1+ y)3
(ii) Half-yearly yield
5
5
5
5
5
5+100
110=
+
+
+
+
+
=3 . 15
1+ y (1+ y)2 (1+ y)3 (1+ y )4 (1+ y )5 (1+ y)6
4 year bond
(i) Annual yield
10 10
10
10+100
115=
+
+
+
=5. 70
1+ y (1+ y)2 (1+ y)3 (1+ y )4
(ii) Half-yearly yield
5
5
5
5
5
5
5
5+100
115=
+
+
+
+
+
+
+
=2 . 87
1+ y (1+ y)2 (1+ y)3 (1+ y )4 (1+ y )5 (1+ y)6 (1+ y)7 (1+ y )8
100=