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Security Valuation
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Lets Start Our Valuation Chapter

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OPTIMUM DIVIDEND AS PER GROWTH MODEL
QUESTION NO.1 (Exam Question) The MNC Ltd.’s available information is: Ke = 15%; EPS = ` 30; Productivity of
Retained Earnings (r) = (i)14%; (ii)15%; and (iii)16%. You are required to calculate market price of a share of the
MNC Ltd., as per Gordon Model if: (i)b = 40% (ii)b = 60% and (iii)b = 80%
Solution:
EPS(1 - b)
As per Gordon's Growth model we have P0 =
Ke - b x r
30(1 - .40) 30(1 - .60)

When r = 14%: (i)b = 40% : P0 = = 191.49; (ii)b = 60% : P0 = = 181.82;
.15 - .40 x .14 .15 - .60 x .14
30(1  .80)
(iii)b = 80% : P0 = = 157.89;
.15  .80 x .14
30(1  .40) 30(1  .60)

When r = 15%: (i)b = 40% : P0 = = 200; (ii)b = 60% : P0 = = 200;
.15  .40 x .15 .15  .60 x .15
30(1  .80)
(iii) b = 80% : P0 = = 200;
.15  .80 x .15
30(1  .40) 30(1  .60)

When r = 16%: (i)b = 40% : P0 = = 209.30; (ii)b = 60% : P0 = = 222.22;
.15  .16 x .40 .15  .60 x .16
30(1  .80)
(iii) b = 80% : P0 = = 272.73;
.15  .80 x .16
GROWTH MODEL
QUESTION NO.2A (Exam Question) A share of T Ltd. is quoted at a price-earning ratio of 7.5 times. The retained
earning per share being 37.5% is ` 3 per share. Compute:
(a)The company's cost of equity if investors expect annual growth rate of 12%
(b)If anticipated growth rate is 13% p.a., calculate indicated market price with same cost of equity.
(c)If the company's Cost of Equity is 18% and anticipated growth rate is 15% p.a., calculate the market price per
share, assuming other conditions remain the same.
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Solution:
D1 5 5 5
(a)P0 = 60 =  Ke =20.33%; (b)P0 = =Rs.68.21; (c)P0 = = Rs.166.67
Ke – g Ke  .12 .2033 – .13 .18 – .15
Working Notes:
Retained Earnings Per Share in percentage 37.5 Amount Retained `3
Therefore Earnings Per Share `8 P/E Ratio 7.5
MPS (7.5 x 8) `60 DPS (`8 - 3) `5
QUESTION NO.2B (Study Material) Starlite Limited is a company having its shares quoted in major stock exchanges.
Dividend paid at the rate of 20% per annum, paid-up shares capital of ` 10 lakhs is ` 10 each. Annual growth rate
in dividend expected is 2%. Ke is 15%. Calculate the value or price of Starlite Limited’s share based on Gordons’
model.
Solution:
No. of Equity Share = 10,00,000/10 = 1,00,000; Dividend Paid = 20% of ` 10,00,000 = ` 2,00,000;
2(1  0.02)
DPS = 2,00,000/1,00,000 = `2; P0 = = `15.69
9
0.15 - 0.02
QUESTION NO.2C (Exam Question)(6 Marks) A firm had been paid dividend at `2 per share last year. The esti-
mated growth of the dividends from the company is estimated to be 5% p.a. Determine the estimated market
price of the equity share if the estimated growth rate of dividends (i)rises to 8%, and (ii)falls to 3%.
Given that the required rate of return of the equity investors is 15.5%.
Solution:
D (1  g) 2(1  .05)
In case the growth rate is 5%: P0 = 0 = = `20.00
Ke  g .155  .05
D0 (1  g) 2(1  .08) D (1  g) 2(1  .03)
Growth rate is 8%: P0 = = = `28.80; Growth rate is 3%: P0 = 0 = = `16.48
Ke  g .155  .08 Ke  g .155  .03
QUESTION NO.2D (Study Material) Amal Ltd. has been maintaining a growth rate of 12% in dividends. The
company has paid dividend @ `3 per share. The rate of return on market portfolio is 15% and the risk-free rate of
return in the market has been observed as 10%. The beta co-efficient of the company’s share is 1.2. You are
required to calculate the expected rate of return on the company’s shares as per CAPM model and the equilibrium
price per share by dividend growth model.
Solution:
Expected Return = Rf + Beta x (Rm - Rf) = 10 + [1.2(15 - 10)] = 16%
3(1  .12)
Applying dividend growth model for the calculation of per share equilibrium price: P0 = = `84
.16 – .12
Therefore, equilibrium price per share will be `84.
QUESTION NO.2E (Study Material) X Ltd. has paid a dividend of `2.5 per share on a face value of `10 in the
financial year ending on 31st March, 2009. The details are as follows:
Growth rate of earnings and dividends 10% Beta of share 0.75
Average market return 15% Risk free rate of return 9%
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Calculate the intrinsic value of the share.

Solution:
D (1  g) 2.5(1  .10)
Intrinsic Value P0 = 0 = = `78.57
7
Ke  g .135  .10
Using CAPM: Ke = Rf + Beta x (Rm - Rf) = 9% + 0.75 (15% - 9%) = 13.5%
QUESTION NO.2F (Study Material) A Company’s share is quoted in market at `60 currently. A company is to pay
a dividend of ` 5 per share and investors expect a growth rate of 12% per year. Compute:
(i)The company’s cost of equity capital.
(ii)If anticipated growth rate is 13% pa. calculate the indicated market price per share, if dividend of `5 per share
is to be maintained.
(iii)If the company’s Cost Of Equity 18% and anticipated growth rate is 15% p.a., calculate the market price per
share, if dividend of `5 per share is to be maintained.
Solution:
D1 5 5 5
(a)P0 =  60 =  Ke = 20.33% (b)P0 =  `68.21 (c)P0 =  `166.67
Ke – g Ke – .12 .2033 – .13 .18 – .15
QUESTION NO.2G (Study Material) A company is to pay a dividend of `2 per share with a growth rate of 7%. The
risk free rate is 9% and the market rate is 13%. The company has a beta factors of 1.50. However, due to a
decision of the finance manager, Beta is likely to increase to 1.75. Find out the present as well as the likely value
of share after the decisions.
Solution:
2
(i) For present data: Ke = 9 + 1.50 (13 - 9) = 15% and P0 = = `25.00
.15 – .07
2
(ii) For revised data: Ke = 9 + 1.75 (13 - 9) = 16% and P0 = = `22.22
.16 – .07
QUESTION NO.2H (Exam Question)(4 Marks) The following information is collected from the annual reports
of J Ltd.
Profit After Tax 1.50 crore Tax rate 40 percent
Retention ratio 40 percent Number of outstanding shares 50,00,000
Equity capitalization rate 12 percent Rate of return on investment 15 percent
What should be the market price per share as per Gordon’s model of dividend policy?
Solution:
Market price per share = 3 (1 - 0.40)/(0.12 - 0.06) = ` 30.00; Earnings per share (` 1.50 crore/ 50,00,000) = `3
Cost of Capital = 12%; Retention Ratio (%) = 40%; r = 15 %; Growth Rate (0.40 x 15%) = 6%
QUESTION NO.2I (Study Material)(Exam Question) With the help of following figures calculate the market price
of a share of a company by using Dividend Growth Model (Gordon's Formula)
Earning Per Share (EPS) ` 10 Dividend Per Share (DPS) `6
Cost of Equity (K) 20% Internal Rate of Return on Investment 25%
Retention Ratio 40%
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Solution:
Market price of share by growth model is given by the following formula:
EPS1 (1 - b) DPS1 10(1 – .4) 6
P0 = or P0 = = 6 = `60 Or = `60
k e – (b x r) k e – (b x r) .20 – (.40 x .25) 0.1 .20 – .40 x .25
Note: Assuming DPS and EPS figure to be DPS 1 and EPS 1.
QUESTION NO.2J M/s X Ltd. has paid a dividend of `2.5 per share on a face value of ` 10 in the financial year
ending on 31st March, 2009. The details are as follows:
Current market price of share ` 60 Growth rate of earnings and dividends 10%
Beta of share 0.75 Average market return 15%
Risk free rate of return 9%
Calculate the intrinsic value of the share.
Solution:
D1 2.5(1  .10)
Intrinsic Value: P0 = = = `78.57 ;
Ke – g .135  .10
Working Notes: Ke = Rf + Beta(Rm - Rf) = 9% + 0.75(15% - 9%) = 13.5%
QUESTION NO.2K (8 Marks) Shares of Volga Ltd. are being quoted at a price-earning ratio of 8 times. The
company retains 50% of its Earnings Per Share. The Company’s EPS is ` 10. You are required to determine:
(1)the cost of equity to the company if the market expects a growth rate of 15% p.a.
(2)the indicative market price with the same cost of capital and if the anticipated growth rate is 16% p.a.
(3)the market price per share if the company’s cost of capital is 20% p.a. and the anticipated growth rate is 18%
p.a.
Solution:
Working Note:
Retained earnings (50%) ` 5 per share Divdend (50%) ` 5 per share
EPS (100%) ` 10 per share given P/E Ratio 8 times (given)
Market price ` 10 x 8 = ` 80 per share
(1)Cost of Capital: Cost of equity capital = (Div/Price ) x 100 + Growth % = (5 / 80) x 100 + 15 % = 21.25 %
Dividend
(2)Market Price = = ` 5/(21.25 - 16)% = ` 95.24 per share
e
Cost of capital %  Growth Rate %
(3)Market Price = ` 5 / (20 - 18 )% = ` 250 per share
QUESTION NO.2L If the same stock is selling for `100 in the stock market, what might the market be assuming
about the growth in dividends?
Solution:
100 = 3 / (0.12 - g) OR g = 0.09
Note: Cover this question after QUESTION NO.2M
QUESTION NO.2M Let’s assume that the shareholder Ms Alka holds the shares of A Ltd for an infinite period. A
Ltd is a matured company giving a constant dividend of ` 3 per share every year. Ms Alka expects 12 % return from
her investment in A Ltd. The value of A Ltd for Ms Alka would be given by the present value of dividend received
forever.
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Solution:
We would simply need to apply the perpetuity formula to calculate the value.
D 3
V0 = 1 = = ` 25 per share
r 12%
We should understand that application of this method would require the valuer to expect that the dividends
would be constant forever, which may be a difficult assumption to make.
QUESTION NO.2N Extending our previous example, Ms Alka hopes that A Ltd will give dividend of ` 3 per share
next year and this is sexpected to grow at a constant rate of 6 % forever. The value of A Ltd today (V0) for Ms Alka
would be given as follows.
Solution:
3
V0 = = ` 50 per share
12%  6%
QUESTION NO.2O The following information is given about Swarnsathi Ltd.

EPS ` 4.00 Rate of return required by shareholders 15%
Assuming that Gordon valuation model holds, what rate of return should be earned on investments to ensure that
the market price is `40 when the dividend payout ratio is 25%?
Solution:
EPS(1 - b) 4.00(1  0.75)
According to the Gordon Model, P0 = or 40 =
k - br 0.15  0.75r
or 40(0.15) – 0.75r x 40 = 4.00 x 0.25 or 6 – 30r = 1 or 30r = 5 or r = 0.167 or 16.7%
The firm should earn a return of 16.7% on its investments
QUESTION NO.2P India Incorporated is expected to grow at the rate of 8% per annum, which currently pays `10
as dividend. For investments at this risk level, investor requires a return of 15% a year, what is the estimated
value of the stock?
Solution:
D1 10(1.08) 10.80
Estimated Value of the stock = V 0     `154.29.
k  g 0.15  0.08 0.07
QUESTION NO.2Q The beta coefficient of M Ltd. Is 1.40. The company has been maintaining 8% rate of growth in
dividends and earnings. The last dividend paid was `4.00 per share. Return on govt. securities is 12% and return
on market portfolio is 18%. The current market price of the share of M Ltd. Is `32.00. What will be the equilibrium
price per share of M Ltd.?
Solution
Required rate of return as per CAPM = Rf + (Rm - Rf) x i = 12 + (18 - 12) x 1.40 = 20.40%.
Expected return = [D1/Po] + g or 20.40 = 4.32/Po + 0.08 or Po = `34.84
Working Note: D1 = 4 x (1 + 0.08) = 4 x 1.08 = ` 4.32
QUESTION NO.2R Estimated present value of stock (V1) of India Incorporated is `154.29 at the end of first year,
if in next year or year two, all the conditions are constant, what will be the value of the stock at the end of the
year 2, if all other data are same as in illustration 2 above?
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Solution:
10.80(1.08) 11.66
V2    ` 166.63 or ` 154.29 x (1.08)
0.15  0.08 0.07
Extra: The estimated value at the end of year 2 is 8% higher than the preceeding year Change in value will be
exactly by the growth rate.
Ending value  Beginning value 166.63  154.29
Change in value    0.8 or 8%
Beginning value 154.29
QUESTION NO.2S Other things being constant, only k is considered 16% instead of 15% above in previous illustration.
Find out the estimated value of the stock.
Solution:
D (1  g) 10(1.08)
Estimative value at the end of year 1  0   ` 135
kg 0.16  0.08
Extra: Conclusion: One percentage change in required return causes [(154.29 – 135)/154.29] or 12.5% change in
value (decrease).
QUESTION NO.2T Other things being constant as in illustration, growth rate is considered 9% instead of 8%, find
out the new valuation of stock.
Solution:
10(1.09) 10.90
  ` 181.67
0.15  0.09 0.06
QUESTION NO.2U A company’s share is currently traded for `80 per share. It is expected that a dividend of `4 per
share after one year will grow at 8% indefinitely. What is the expected return?
Solution:
k = [(Div1) / P0] + g = [4 / 80] + 0.08 = 0.13 or 13%
QUESTION NO.2V Removed
QUESTION NO.2W Zed Ltd. is currently selling for `60 per share and is expected to pay a dividend of `3.00. The
expected growth rate in dividends is 8 percent for the foreseeable future. Calculate the required rate of return for
this stock.
Solution:
To solve this problem for k, we can simply rearrange the equation of basic DDM.
D 3.00
k = 1 + g; or k = + 0.08 = 0.13 or 13%
P0 60
QUESTION NO.2X X Ltd. pays a dividend of `1.22, which is expected to grow indefinitely at 5%. If the current
value of X Ltd’s share based on the constant DDM is `40.00, what is the required rate of return?
Solution:
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D (1  g) 1.22(1.05)
k 0 g  0.05  8.20%
P0 40
QUESTION NO.2Y (a) Software stocks currently provide an expected rate of return of 16%. Zed Ltd. a large
computer company, will pay a year end dividend of `2.00 per share. If the stock is currently selling at `50 per
share, what must be the market’s expectations of the growth rate of Zed Ltd. dividends?
(b) If dividend growth forecasts for Zed Ltd. are revised downward to 5% per year, what will happen to the price
of Zed Ltd. stock? What (qualitatively) will happen to the company’s price-earnings ratio?
Solution:
D 2.00 D 2
(a) k = 1 + g or 0.16 = + g or g = 12% (b) P0  1   18.18
P0 50 k  g 0.16  0.05
The price falls in response to the more pessimistic dividend forecast. The forecast for current year earnings,
however, is unchanged. Therefore, the P/E ratio falls. The lower P/E ratio is evidence of the diminished optimism
concerning the firm’s growth prospects.
Note:We assumed Dividend to remain same under both the situation.
QUESTION NO.2Z Removed
APPLICATION OF FLOTATION COST
QUESTION NO.3 The current market price is ` 125 per share. D0 = 14; The floating costs are expected to be 4% of
issue price which is ` 125; g = 8.776%. Determine: (i)Cost (Ke) of existing equity share (ii) Cost (Ke) of new equity
Solution:
D (1  g) 14(1  .08776)
(i)Cost of Existing Equity Shares (Ke): P0 = 0 125 = Ke = 20.95%
Ke – g Ke – .08776
D (1  g) 14(1  .08776)
(ii)Cost of New Equity (Ke): P0(1 - f) = 0 125(1 - .04) = Ke = 21.47%
Ke – g Ke – .08776
HOLDING PERIOD RETURN (HPR)
QUESTION NO.4A Tata is to pay dividend of ` 2.15 at the end of the year and it is expected to grow at 11.2% p.a,
and Cost Of Equity is 15.2% per annum.
(i)What is its intrinsic value i.e Po as on today? (ii)What is the next year expected price at the end of year 1?
(iii)If an investor wants to buy Tata stock now and sell it after receiving ` 2.15 dividend a year from now, what is
the expected capital gain in % terms? What is the dividend yield and what is the holding period return?
Solution:
D (1  g) 2.15
(i)Intrinsic Value (P0) = 0 = = 53.75
5
Ke – g .152 – .112
D1  P1 2.15  P1
(ii)Intrinsic Value (P0) = 53.75 = P1 = 59.77
7
(1  Ke )1 (1  .152)1
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(iii) Expected Capital Gain: P1 - P0 = 59.77 - 53.75 = 6.02

6.02 DPS 2.15
Capital Gain Yeild = x 100 = 11.2%; Dividend Yield = x 100 = x 100 = 4%
53.75 MPS 53.75
Holding Period Return = Dividend Yield + Capital Gain Yield = 11.2% + 4% = 15.2%
QUESTION NO.4B (RTP) T Ltd. has been growing at a rate of 20 % (g supernormal) in recent year. This same
growth rate is expected to last for another 2 years. If D0 = 1.60, k = 10%, and g normal after 2nd year = 6% p.a
forever.What is T Ltd’s stock worth today? What are its expected dividend yield and capital gains yield at this
time?
Solution:
1.92 2.304  2.44224  1

P0 = + +  x = 1.92 x .909 + 2.304 x .826 + 61.06% x .826 = £ 54.11
(1  .10)1 (1  .10)2  .10  .06  (1  .10)2
D 1.92 P –P 57.60 – 54.11
Dividend Yield = 1 = x 100 = 3.55%; Capital Gain Yield = 1 0 = = 6.45%
5%
P0 54.11 P0 54.11
P1  D1 P  1.92
Working Note: Calculation of P1: PO = OR 54.11 = 1 P1 = 57.60
(1  Ke )
(1  .10)1
QUESTION NO.4C If Modern Electronics is selling for `100 per share today and is expected to sell for `110 one
year from now, what is the expected return if the dividend one year from now is forecasted to be `5.00?
Solution:
Expected Return = r = (5 + 110 - 100) / 100 = 0.15
QUESTION NO.4D Mr. Amit bought 10 shares of TCS on 1.4.2018 for `30,050. The company paid a dividend of `30
per share and the value of the stock as on 31.3.2019 was `34,280. Calculate the holding period yield of the
investor.
Solution:
Holding period return: = [(`34,280 - `30,050) + `300]/(`30,050) = 15.07%.
It is better to split it into two parts (a) Current yield; and (b) Capital appreciation.
Current yield = (Dividend received)/(Initial investment) = (`300)/(`30,050) = 0.00998
Capital appreciation = (Closing value-Opening value )/(Initial investment)= (`34,280 - `30,050)/(`30,050) = 0.14076
Total yield = 0.00998 + 0.14076 = 15.07%.
VARIABLE/UNEQUAL GROWTH RATE
QUESTION NO.5A (Exam Question)(8 Marks) Z Ltd. will have a growth rate of 12% per annum in the next 2 years.
The growth rate is likely to fall to 10% for the third year and fourth year. After that the growth rate is expected to
stabilize at 8% p.a forever. If dividend paid was ` 1.50 per share and the investor’s required rate of return is 16%,
find out the intrinsic or Fair value i.e Po per share of Z Ltd. as of date i.e. as on today .
You may use the following table:
Years 0 1 2 3 4 5
Discounting Factors at 16% 1 0.86 0.74 0.64 0.55 0.48
Solution:
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D1 D2 D3 D4 D (1  g) 1
P0 = + + + + 4 x
1  Ke (1  Ke)2 (1  Ke)3 (1  Ke)4 Ke – g (1  Ke)4
1.68 1.88 2.07 2.28 2.46 1.

=     x = (1.68 x 0.86) + (1.88 x 0.74) + (2.07 x 0.64) +
1  .16 (1  .16)2 (1  .16)3 (1  .16)4 .16 - .08 (1  .16)4
(2.28 x 0.55) + 0.55 x 30.75 = 1.4448 + 1.3912 + 1.3248 + 1.254 + 16.9125 = `22.3273 or `22.33 (approx)
QUESTION NO.5B (Study Material) MNP Ltd. has declared and paid annual dividend of ` 4 per share. It is
expected to grow @ 20% for the next two years and 10% thereafter. The required rate of return of equity investors
is 15%. Compute the current price at which equity shares should sell.
Note: Present Value Interest Factors (PVIF) @ 15%: For year 1 = 0.8696; For year 2 = 0.7561
Solution:
P0 = 4.80 x 0.8696 + 5.76 x 0.7561 + 126.72 x 0.7561 = 104.34
D3 6.336
Working Notes: 1. D0 = ` 4; D1 = `4.80; D2 = `5.76; D3 = ` 6.336; 2. P2  = = 126.72
2
Ke - g .15 - .10
QUESTION NO.5C (8 Marks) An investor is considering purchasing the equity shares of LX Ltd., whose current
market price (CMP) is 150. The company is proposing a dividend of ` 6 for the next year. LX is expected to grow
@ 18 per cent per annum for the next four years [Hint: 18% growth rate is upto 4 years end]. The growth will
decline linearly to 14 percent per annum after first four years [Hint: It means every year it will fall by 1% till the
growth rate becomes 14%]. Thereafter, it will stabilize at 14 percent per annum infinitely. The required rate of
return is 18 percent per annum. You are required to determine:
(i)The intrinsic value of one share (ii) Whether it is worth to purchase the share at this price
t 1 2 3 4 5 6 7 8
PVIF (18, t) 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266
Solution:
D1 = ` 6; D2 = ` 6 (1.18) = ` 7.08; D3 = ` 7.08 (1.18) = ` 8.35;
D4 = ` 8.35(1.18) = ` 9.86 D5 = ` 9.86 (1.17) = ` 11.54; D6 = ` 11.54 (1.16) = ` 13.38;
D7 = ` 13.38 (1.15) = ` 15.39 D8 = ` 15.39 (1.14) = ` 17.54
P0 or intrinsic value of one share = 6.00 x 0.847 + 7.08 x 0.718 + 8.35 x 0.609 + 9.86 x 0.516 + 11.54 x 0.437 +
13.38 x 0.370 + 15.39 x 0.314 + ` 17.54 / (.18 - .14) x 0.314 = ` 172.85
Comment: Since the Intrinsic Value of share is ` 172.85 while it is selling at `150 hence it is underpriced and
better to acquire it.
QUESTION NO.5D (8 Marks) The shares of G Ltd. are currently being traded at ` 46. The company published its
results for the year ended 31st March 2019 and declared a dividend of ` 5. The company made a return of 15% on
its capital and expects that to be the norm in which it operates. G Ltd. Also expects the dividends to grow at 10%
for the first three years and thereafter at 5%. You are required to advise whether the share of the company is
being traded at a premium or discount. PVIF @ 15% for the next 3 years is 0.870, 0.756 and 0.658 respectively.
Hint: Table value of 15% is given , it means Discount Rate is 15%.
Solution:
Expected dividend for next three years:
Year 1 (D1) = 5 (1.1) = 5.5; Year 2 (D2) = 5.5 (1.1) = 6.05; Year 3 (D3) = 6.05 (1.1) = 6.655
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(6.655)(1.05)
Present Value = 5.5 (0.870) + 6.05 (0.756) + 6.655 (0.658) + x 0.658 = 59.72
2
0.15  0.05
Decision: Hence, it is clear that shares are being traded at discount i.e. undervalued because intrinsic value of
share is more than the market price.
QUESTION NO.5E Removed
QUESTION NO.5F Removed
QUESTION NO.5G Python Ltd currently pays a dividend of ` 2 per share. A valuer forecasts growth of 15% for the
next three years, followed by 4% growth in perpetuity thereafter. The required return is 13%. Calculate the current
value per share.
Solution:
The Present Value Factors for the first 3 years are as follows:
Year 1: 0.8850 ; Year 2: 0.7832 ; Year 3: 0.6931
2.30 2.65 3.04 1  3.16 
P0      
1  .131 1  .132 1  .133 1  .133  (0.13  0.04) 
P0 = (2.30 x 0.8850) + (2.65 x 0.7832) + (3.04 x 0.6931) + 0.6931 X (3.16 ÷ 0.09)
=2.0355 + 2.0748+2.107024+24.3355 =` 30.55
QUESTION NO.5H Consider the equity share of India Incorporated

D0 = Current dividend per share `3.00
n = Duration of the period of super normal growth = 5 years
ga = Growth rate during the period of super normal growth = 25%
gn = Normal growth rate after super normal growth period is over = 7%
k = Investor’s required rate of return = 14%
Solution:
The following are the steps involved:
Step I. Dividend stream during super normal growth period.
D1 = `3.00 (1.25); D2= `3.00 (1.25)2; D3 = `3.00 (1.25)3; D4 = `3.00 (1.25)4 and D5 = `3.00 (1.25)5
The present value of the above stream of dividends is
3.00(1.25) 3.00(1.25)2 3.00(1.25)3 3.00(1.25)4 3.00(1.25)5

    = ` (3.29 + 3.61 + 3.96 + 4.34 + 4.76) = ` 19.96
(1.14) (1.14)2 (1.14)3 (1.14)4 (1.14)5
Step II. The price of the shares at the end of 5 years, applying the constant growth model at that point of time will
D6 D5 (1  gn ) 3.00(1.25)5 (1.07)
be P5     ` 140
kg k  gn 0.14  0.07
140
Discounted value of this price = = ` 72.71
(1.14)5
Step III. The sum of Steps I and II is `19.96 + `72.71 = `92.67
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QUESTION NO.5I For the first four years, India Incorporated is assumed to grow at a rate of 10%. After four years,
the growth rate of dividend is assumed to decline linearly to 6 percent. After 7 years, it is assumed to grow at a
rate of 6% infinitely. The next year dividend is `2.00 per share and the required rate of return is 14%. Find the
value of the stock.
Solution:
where D0= 2.00; ga= 0.10; gn= 0.06; k = 0.14; Db =declining rate of return from 10% to 6 %, i.e. 0.09, 0.08, 0.07, 0.06.
B = 7 years
2 3 3 3 3
2  2(1.1)  2(1.1)  2(1.1)  2(1.1) (1.09)  2(1.1) (1.09)(1.08)  2(1.1) (1.09)(1.08)(1.07)
1.14 1.142 1.14 3 1.14 4 1.14 5 1.14 6 1.147
 3 
 1  2(1.1) (1.09)(1.08)(1.07)(1.06) 
1.14 7  (0.14 0.06)  = `(6.66+4.27+17.76) = `28.69, The present value of the stock is `28.69

QUESTION NO.5J Shifted To Q.31A
QUESTION NO.5K Shifted To Q.31B
QUESTION NO.5L Shifted To Q.32
OVERVALUED & UNDERVALUED SHARES
QUESTION NO.6A (Exam Question) The Beta Co-efficient of Target Ltd. is 1.4. The company has been maintaining
8% rate of growth in dividends and earnings. The last dividend paid was `4 per share. Return on Government
securities is 10%. Return on market portfolio is 15%. The current market price of one share of Target Ltd. is ` 36.
What will be the equilibrium or fair price per share of Target Ltd. Would you advice purchasing the share?
Solution:
As per CAPM Model, Ke = Rf + Beta (Rm – Rf) = 10% + 1.4 (15 - 10) = 17%
Do (1  g) 4 (1  .08)
Now equilibrium price per share will be P0 =   48
Ke – g .17 – .08
As per valuation model equilibrium price of the share should be Rs. 48. But its current market price is ` 36. Hence
it is recommended or advised to purchase the share at market price.
QUESTION NO.6B (MOCK TEST PAPERS )(8 Marks) Two companies X Ltd. and Y Ltd. paid a dividend of ` 3.50 per
share. Both are anticipating that dividend shall grow @ 8%. The beta of X Ltd. and Y Ltd. are 0.95 and 1.42
respectively. The yield on GOI Bond is 7% and it is expected that market annual rate is 13%. You are required to
determine: (i)Value of share of both companies. (ii)Why there is a difference in the value of shares of two
companies. (iii)If current market price of share of A Ltd. and B Ltd. are ` 74 and ` 55 respectively. As an investor
what course of action should be followed?
Solution:
(i)First compute(Ke): X Ltd. = 7.00% + (13% - 7%) x 0.95 = 12.7%; Y Ltd. = 7.00% + (13% - 7%) x 1.42 = 15.52%
3.50(1  .08) 3.50(1  .08)
Value of share of both companies: PX   80.43 ; PY   50.27
.127  .08 .1552  .08
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(ii) The difference in value of two companies is due to difference in beta,since all other data including growth
rate of both companies are same. Value of share of X Ltd. is higher because systematic risk i.e. Beta is lower.
(iii) If Actual Price of share of X Ltd. is ` 74, it is undervalued and it should be bought as Fair Po is ` 80.43
If Actual Price of share of Y Ltd. is ` 55, it is overvalued and should not be bought as Fair Po is ` 50.27
QUESTION NO.6C Following are the details of X Ltd. and Y Ltd.:

Particulars X Ltd. Y Ltd.
Dividend per Share `4 `4
Growth Rate 10% 10%
Beta 0.9 1.2
Current Market Price per Share ` 150 ` 70
Other Information:
Risk Free Rate of Return 7%
Market Rate of Return 14%
(i)Calculate the price of shares of both the companies.
(ii)Write the comment on the valuation on the basis of price calculated and current market price.
(iii)As an investor what course of action should be followed?
Solution:
(i)Calculation of Prices of shares of both companies
X Ltd. Y Ltd.
Beta 0.9 1.20
Cost of Equity using CAPM 7% + 0.9 [14% - 7%] = 13.30% 7% + 1.20 [14% - 7%] = 15.40%
Growth Rate 10% 10%
4 x 1.10 4.40 4 x 1.10 4.40
Price of Share  = ` 133.33  = ` 81.48
0.133  0.10 0.033 0.154  0.10 0.054
(ii) and (iii)
Name of Current Value of Valuation Action of the
Company Market Price the Share Investor
X Ltd. ` 150.00 ` 133.33 Overvalued/ overpriced Not to Invest/ to be sold
Y Ltd. ` 70.00 ` 81.48 Undervalued/ under-priced Invest/ to be purchased
Alternatively, if the given figure of Dividend is considered as Dividend Expected (D1) then solution will be as
follows: X Ltd. Y Ltd.
Beta 0.9 1.20
Cost of Equity using CAPM 7% + 0.9[14% - 7%] = 13.30% 7% + 1.20[14% - 7%] = 15.40%
Growth Rate 10% 10%
4.00 4.00 4.00 4.00
Price of Share  = ` 121.21  = ` 74.07
0.133  0.10 0.033 0.154  0.10 0.054
(ii) and (iii)
Name of Current Value of Valuation Action of the Investor
Company Market Price the Share
X Ltd. ` 150.00 ` 121.21 Overvalued / overpriced Not to Invest/to be sold
Y Ltd. ` 70.00 ` 74.07 Undervalued / under-priced Invest/to be purchased
NEGATIVE GROWTH RATE
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QUESTION NO.7 Arvind has invested in Gujarat Chemicals. The capitalisation rate of the company is 15 % and
the current dividend i.e. Do is ` 2 per share. Calculate the price of the company’s equity share if the company is
slowly declining with an annual decline rate of 5% in the dividend.
Solution:
D o (1  g) D [1  (–.05)] 2(1 – .05)
As per Dividend Growth Model, Po = P0   Po  o  Po   Po  Rs. 9.50.
Ke  g Ke – (–.05) .15  .05
IRR TECHNIQUE & GROWTH MODEL
QUESTION NO.8 (Study Material)Piyush Ltd presently pay a dividend of ` 1.00 per share and has a share price
of ` 20.00.
(i)If this dividend were expected to grow at a rate of 12% per annum forever, what is the firm’s expected or
required Cost Of Equity using a dividend-discount model approach?
(ii)Instead of this situation in part (i), suppose that dividend were expected to grow at a rate of 20% p.a. for 5
years and 10% per year thereafter. Now what is the firm’s expected, or Cost Of Equity ?
Solution:
D o (1  g) 1 (1  .12)
(i)As per Dividend discount model approach we have: Po   20   Ke  17.6%
Ke – g Ke – .12
D1 D2 D3 D4 D5 1  D 5 (1  g) 
(ii)We know that, Po        
(1  Ke )1 (1  Ke )2 (1  Ke )3 (1  Ke )4 (1  Ke )5 (1  Ke )5  Ke  g 
1.20 1.44 1.73 2.07 2.49 2.49 (1  .10) 1

20       
(1  Ke )1 (1  Ke )2 (1  Ke )3 (1  Ke )4 (1  Ke )5 Ke – .10 (1  Ke )5
Lets assume Ke = 18%
Now, Present Value of the inflows of dividend at the rate of 18% will be:-
2.49 (1  .10)
1.20 x .8475 + 1.44 x .7182 + 1.73 x .6086 + 2.07 x .51589 + 2.49 x .43710 +  .4371 = Rs. 20.23
.18 – .10
and Present Value of the Outflows = Rs. 20
Therefore NPV = PV of inflows - PV of outflows = 20.23 - 20 = .23
Since the present value of dividend stream is positive it indicates that Ke is greater than 18%. In other words,
since the NPV is positive it indicates that other rate must be higher.
Now assume Ke = 19%
Present Value of the inflows of dividend at the rate of 19% will be:
2.49 (1  .10)
1.20 x .8403 + 1.44 x .7061 + 1.73 x .5934 + 2.07 x .4986 + 2.49 x .4190 +  .4190 = 17.89
.19 – .10
and Present Value of the outflows = Rs. 20; Therefore, NPV = PV of inflows – PV of outflows = 17.89 – 20 = - 2.11
Now we can get the exact answer by IRR formula:
Lower Rate NPV .23
Ke = Lower Rate +  Difference in rates = 18% +  1%  18.10%
Lower Rate NPV – Higher Rate NPV .23  2.11
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Hence if dividends were expected to grow at a rate of 20% p.a. for 5 years and 10% per year thereafter the firms
expected rate of return on its equity is 18.10 %.
BOOK VALUE PER SHARE (BVPS)/WALTER’S MODEL
QUESTION NO.9 (Study Material) A Ltd. has a book value per share of ` 137.80. Its return on equity is 15% and
it follow a policy of retaining 60% of its earnings. If the opportunity Cost Of Equity is 18%, what is price of share
today as per Perpetual Growth Model & Walter Model ?
Solution:
Given: Book Value per share = ` 137.80, r = 15%, b = 60%; Ke = 18%, (1 – b) = Dividend payout = 40%,
r 15
(EPS – DPS) . (20.67 – 8.268)
DPS Ke 8.268 .18
As per Walter's Model: Po =  =  = ` 103.35
Ke Ke .18 .18
EPS1  (1 – b) 20.67  (1 – .60)
As per Gordon Model: Po =  = `91.87
Ke – b.r .18 – .60  .15
Working Notes:(i)EPS=Book Value per share x Return on Equity=137.80x15%=20.67(ii)DPS = 40% of 20.67= 8.268
INCREASE OR DECREASE IN MPS DUE TO INVESTMENT
QUESTION NO.10 If Current MPS of the Company as per its existing policy is `10 and its has 1,00,000 shares
outstanding. Now Company is undertaking an investment which is giving a positive NPV of ` 2,00,000. What
should be the revised MPS?
Solution:
Revised MPS = Current MPS + Increased MPS due to positive NPV = 10 + 200000/100000 = 12
HOME MADE DIVIDEND
QUESTION NO.11 (Study Material) SAM Ltd. has just paid a dividend of ` 2 per share and it is expected to grow
@ 6% p. a. After paying dividend, the Board declared to take up a project by retaining the next three annual
dividends. It is expected that this project is of same risk as the existing projects.
The results of this project will start coming from the 4th year onward from now. The dividends will then be ` 2.50
per share and will grow @ 7% p. a.
An investor has 1,000 shares in SAM Ltd. and wants a receipt of atleast ` 2,000 p.a. from this investment.
(a)Show that the market value of the share is affected by the decision of the Board.
(b)Also show as to how the investors can maintain his target receipt from the investment for first 3 years and
improved income thereafter, given that the cost of equity of the firm is 8%.
Solution:
2(1  .06)
(a)Value of share at present  = ` 106
.08  .06
However, if the Board implement its decision, no dividend would be payable for 3 years and the dividend for year
4 would be ` 2.50 and growing at 7% p.a. The price of the share, in this case, now would be:
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 2.5  1
   = ` 198.46
 .08  .07  (1  .08)3
So, the price of the share is expected to increase from ` 106 to ` 198.45 after the announcement of the project.
(b)The investors can take up this situation as follows:
Expected market price after 3 years 2.50/0.08 - 0.07 = ` 250.00
Expected market price after 2 years 2.50/ 0.08 - 0.07 x 1/(1 + 0.08) = ` 231.48
Expected market price after 1 year 2.50/ 0.08 - 0.07 x 1/ (1 + 0.08)2 = ` 214.33
In order to maintain his receipt at ` 2,000 for first 3 years, he would sell
10 shares in first year @ ` 214.33 for ` 2,143.30
9 shares in second year @ ` 231.48 for ` 2,083.32
8 shares in third year @ ` 250 for ` 2,000.00
At the end of 3rd year, he would be having 973 shares valued @ ` 250 each i.e. ` 2,43,250. On these 973 shares,
his dividend income for year 4 would be @ ` 2.50 i.e. ` 2,432.50.
So, if the project is taken up by the company, the investors would be able to maintain his receipt of at least `
2,000 for first three years and would be getting increased income thereafter.
CALCULATION OF GROWTH RATE
QUESTION NO.12A The dividends paid by a company over the last few years are :
Years 1997 1998 1999 2000 2001
DPS (`) 1.00 1.10 1.21 1.33 1.46
Estimate the growth rate ?
Solution:
DPSLatest year  DPSBase year (1  g)n1 or 1.46 = 1(1  g)n1 or g = 10%
QUESTION NO.12B (RTP) Beta for ordinary shares of a company is 1.6 and its market risk premium[Rm - Rf] is 5%.
The risk free return is 10%. The latest(current) dividend declared by the company on 31/ 03/ 03 is ` 3. Dividend
declared by the company on 31/ 03/ 97 was ` 2.115 per share. The company’s earnings and the dividend experienced
constant growth. Find out the intrinsic(fair)value of the shares. Take into account the following PV factors
table value. Cost of capital PV factors (Year 6)
5% 0.746
6% 0.705
7% 0.666
Solution:
Do (1  g) 3(1 + g) 3(1  .06)
Intrinsic value: P0 =  P0 =  P0 =  P0 = ` 26.50
(Ke – g) Ke – g .18 – .06
Working Note: (1)Calculation of Growth Rate: We know that, Dn = Do (1 + g)n-1  3 = 2.115 (1 + g)7-1
3 1 1 1
 = (1 + g)7-1 (1 + g)6 = 1.418  =   .705
2.115 (1  g)6 (1.418) (1  g)6
Now from the present value table given in question, we can find that g = 6% [ approximately]
(2)Calculation of Ke: Ke = Rf + Beta (Rm - Rf) = 10% + 1.6 (5%) = 18%
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Tutorial Note: Why n = 7 ?

31-3-97 2.115 - Base Year Dividend
31-3-98
31-3-99
31-3-00
31-3-01
31-3-02
31-3-03 3.000 - Latest / Current Year Dividend
Now from 31-3-97 to 31-3-03 it’s coming 7 years
ASSET TURNOVER RATIO (ATR)
QUESTION NO.13A(6 Marks)(Exam Question) Following Financial data are available for PQR Ltd. for the
years ending 2008 [Hint:Means Year 0] (` In lakh)
8% Debentures 125 10% Bonds (2007) 50
Equity shares (` 10 each) 100 Reserve and Surplus 300
Total Assets 600 Assets Turnover ratio 1.1
Effective Interest rate 8% Tax rate 40%
[Hint: Both For Debenture & Bond ]
Current market Price of Shares 14 Required Rate of return of investors (Ke) 15%
Operating Profit Margin 10% Dividend payout ratio for the years
ending 2008 (Hint:Do) 16.67%
You are required to: (i)Draw income statement for the year ending 2008 [Hint: Means Year 0] (ii)Calculate its
growth rate (iii)Calculate the fair price of the company’s shares using dividend discount model, and (iv)What is
your opinion on investment in the company’s share at current price?
Solution:
(i)Workings:
Asset Turnover Ratio = 1.1
Total Assets = ` 600
Turnover ` 600 lakhs x 11 = ` 660 lakhs
Effective interest rate = 8%
Liabilities = ` 125 lakhs + 50 lakhs = 175 lakh
Interest = ` 175 lakhs x 0.08 = ` 14 lakh
Operating Margin = 10%
Hence operating cost = (1 - 0.10) `660 lakhs = `594 lakh
Dividend Payout = 16.67%
Tax rate = 40%
(i)Income statement (` In Lakhs)
Sale 660
Operating Exp 594
EBIT 66
Interest 14_
EBT 52
Tax @ 40% 20.80
EAT 31.20
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Dividend @ 16.67% 5.20_

Retained Earnings 26.00
Earning For Equity 31.2 Lakhs
(ii)Growth Rate = g = b x r ; ROE (r) = = x 100 = 7.8 %
Equity Shareholde r' s Fund 400 Lakhs
b = Retention Ratio = 1 - Dividend Payout Ratio = 1 - .1667 = .8333; g = 0.078 x .8333 = 6.5%
Note: We should always prefer g = b x r equation for growth rate calculation.
DPS0 (1  g) .52(1  .065)
(iii)Calculation of fair price of share using dividend discount model: Po = = = `6.51
Ke - g .15 - .065
5.2 Lakhs
Working Note: DPS =
10 Lakhs
Additional Analysis: When Past Year Data is given in question,and dividend is calculated using past year data
then calculated Dividend will be Do.
(iv)Comment: Since the current market price of share is `14, the share is overvalued. Hence the investor should
not invest in the company.
QUESTION NO.13B(Exam Question)(8 Marks) Following Financial Data for platinum Ltd. are available:
(` in lakhs)
Equity Share (10 each) 100 8% Debentures 125
10% Bonds 50 Reserves and surplus 200
Total Assets 500 Asset turnover Ratio 1.1
Effective Tax Rate 30% Operating Margin 10%
Required rate of return of investors 15% Current market price of shares ` 13
Dividend payout ratio for the year ending 2008 (Do) 20%
You are required to: (i)Draw income statement for the year (ii)Calculate the growth rate (iii)Compute the fair
price of the company‘s share using dividend discount model, and (iv)Draw your opinion on investment in the
company’s share at current price.
Solution:
(i)Workings:
Asset turnover ratio = 1.1
Total Assets = `500 lakhs
Turnover ` 500 lakhs x 1.1 = `550 lakhs
Interest = `125 lakhs x 0.08 + `50 lakhs x 0.10 = `15 lakh
Operating Margin = 10%
Hence operating cost = (1 - 0.10) `550 lakhs = `495 lakh
Dividend Payout = 20%
Tax rate = 30%
(i)Income statement (` Lakhs)
Sale 550.00
Operating Exp 495.00
EBIT 55.00
Interest 15.00
EBT 40.00
Tax @ 30% 12.00
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EAT 28.00
Dividend @ 20% 5.60
(ii)SGR = G = ROE (1 - b)
PAT
ROE = and NW = `100 lakhs + `200 lakhs = `300 lakhs
NW
28 lakhs
ROE = x 100 = 9.33% ; SGR = 0.0933(1 - 0.20) = 7.47%
300 lakhs
D0 (1  g)
(iii)Calculation of fair price of share using dividend discount model Po =
ke  g
5.6 lakhs
Dividends = = ` 0.56 ; Growth Rate = 7.47%
10 lakhs
0.56(1  0.0747) 0.6018
Hence Po = = = `7.99 say `8.00
0.15  0.0747 0.0753
(iv)Since the current market price of share is `13.00, the share is overvalued. Hence the investor should not
invest in the company.
QUESTION NO. 13C (8 Marks) Following financial informations are available of XP Ltd. for the year 2018:
Equity Share Capital (` 10 each) ` 200 Lakh Reserves and Surplus ` 600 Lakh
10% Debentures (` 100 each) ` 350 Lakh Total Assets ` 1200 Lakh
Assets Turnover Ratio 2 times Tax Rate 30%
Operating Margin 10% Dividend Payout Ratio 20%
Current Market Price per Equity Share ` 28 Required Rate of Return of investors 18%
You are required to: (i)Prepare Income Statement for the year 2018. (ii)Determine its Sustainable Growth Rate.
(iii)Determine the fair price of the company’s share using Dividend Discount Model. (iv)Give your opinion on
investment in the company’s share at current price.
Solution:
Workings:
Asset turnover ratio 2 times
Total Assets ` 1200 lakh
Turnovers ` 1200 lakhs x 2 ` 2400 lakh
Interest on Debentures 250 lakh x 10 % = 35 lakh
Operating Margin 10 %
Hence operating cost (1 - 0.1) 2400 lakh = 2160 lakh
Dividend Payout 20 %
Tax rate 30 %
(i)Income statement (` Lakhs)
Sale 2400
Operating Exp 2160
EBIT 240
Interest 35
EBT 205
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Tax @ 30% 61.5

EAT 143.5
Dividend @ 20% 28.7
(ii)SGR = Return on Equity (1 - Dividend Payout Ratio)
ROE = PAT / Net worth and Net worth = ` 200 lakh + ` 600 lakh = ` 800 lakh
ROE = (` 143.5 lakh / ` 800 lakh) x 100 = 17.94%; SGR = 0.1794 (1 - 0.20) = 14.35%
(iii)Calculation of fair price of share using dividend discount model
D 1  g 
Po = 0 ; Dividends = ` 28.7 lakhs / 20 lakhs = `1.435; Growth Rate = 14.35%
Ke  g
1.435(1  0.1435)
Hence, Po = = 1.64 / 0.0365 = ` 44.93 or 44.96
0.18  0.1435
(iv)Decision: Since the current market price of share is ` 28, the share is undervalued. Hence, the investors
should invest in the company.
DECISION WHEN INVESTOR IS ALREADY HOLDING SHARE
QUESTION NO.14A (Study Material) An investor is holding 1,000 shares of F Ltd. Company. Presently the rate of
dividend being paid by the company is ` 2 per share and the share is being sold at ` 25 per share in the market.
However, several factors are likely to change during the course of the years as indicated below:
Existing Situation Revised Situation
Risk free rate 12% 10%
Market risk premium (Rm - Rf) 6% 4%
Beta value 1.4 1.25
Expected growth rate 5% 9%
In view of the above, advise whether the investor should buy, hold or sell the shares.
Hint: (i)Calculate Fair Price Per Share Under Existing & Revised Situation. (ii)Compare these price with CMP of `
25 and state whether the given investors should hold or sell the shares? And why?
Solution:
On the basis of existing and revised factors, rate of return and price of share is to be calculated :
Existing Rate of Return = Rf + Beta(Rm – Rf) = 12% + 1.4 (6%) = 20.4%
Revised Rate of Return = Rf + Beta(Rm – Rf) = 10% + 1.25 (4%) = 15%
D (1  g) 2 (1  .05) 2.10
Price of share (original)Po = o = = = ` 13.63
Ke – g .204 – .05 .157
D (1  g) 2 (1  .09) 2.18
Price of share (Revised) Po = o =  = 36.33
Ke – g .15 – .09 .06
Existing Situation: Existing Market Price = Rs. 25 per share. Equilibrium Market Price = ` 13.63 per share.
Decision: This share needs to be sold because the share is overpriced by ` 11.37 (` 25 – ` 13.63) and at any time
it can come down to its equilibrium price of `13.63
Changed/Revised Situation: Existing Market Price = `25 per share; Equilibrium Or Possible Market Price of share
is 36.33
Decision: This share needs to be hold.
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QUESTION NO.14B (Study Material) An investor is holding 5,000 shares of X Ltd. Current year dividend rate is `
3 per share.Market price of the share is ` 40 each. The investor is concerned about several factors which are
likely to change during the next financial year as indicated below:
Existing or Current Year Revised or Next Year
Dividend paid 3 2.5
Risk free rate 12% 10%
Market Risk Premium 5% 4%
Beta Value 1.3 1.4
Expected growth 9% 7%
In view of the above, advise whether the investor should buy, hold or sell the shares.
Solution:
Ke = Rf + Beta (Rm – Rf): Existing Ke 12% + 1.3 (5%) = 18.5%; Revised Ke = 10% + 1.4 (4%) = 15.60%
3(1  .09) 2.5(1  .07)
Price(Original) = = 34.42; Price(Revised) = = 31.10
.185 - .09 .156 - .07
Existing Situation: Existing Market Price = ` 40 per share. Equilibrium Market Price = ` 34.42 per share.
Decision: This share needs to be sold because the share is overpriced
Changed/Revised Situation: Existing Market Price = ` 40 per share; Equilibrium Price of share is ` 31.10
Decision: This share needs to be sold because the share is overpriced.
VALUE AS PER PE MULTIPLE APPROACH AND EARNING GROWTH MODEL
QUESTION NO.15A (Study Material) On the basis of this information :

Current dividend (Do) = ` 2.50; Discount rate (k) = 10.5%; Growth rate (g) = 2%
(i)Calculate the present value of stock of ABC Ltd.
(ii)Is this stock overvalued if stock price is ` 35, ROE = 9% and Current EPS = ` 2.25
Show your calculations under the PE Multiple approach and Earning Growth model.
Hint: 1.Assume given EPS is of Year 0 2.Assume ROE to be Ke
Solution:
Do (1  g) 2.50(1  .02)
(i)Present Value of stock of ABC Ltd. (Po) = = = `30
Ke - g .105  .02
(ii)(a)Value of stock under the PE Multiple Approach
Particulars
Actual Stock Price ` 35.00
Return on equity 9%
EPS ` 2.25
PE Multiple (1/Return on Equity) = 1/9% 11.11
Market Price per Share ` 25.00
Decision: Since, Actual Stock Price is higher, hence it is overvalued.
(b) Value of the Stock under the Earnings Growth Model
Particulars
Return on equity 9%
EPS ` 2.25
Growth Rate 2%
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EPS(1  g) 2.25(1  .02)

Market Price per Share = ` 32.79
Ke  g .09  .02
Decision: Since, Actual Stock Price is higher, hence it is overvalued.
QUESTION NO.15B (8 Marks)(Exam Question) Given the following information :

Current dividend(D0): ` 5.00; Ke 10%; Growth rate(g) : 2%
(i)Calculate the present value of the stock. (ii)Is the stock over valued if price is ` 40, ROE = 8% and EPS = ` 3.00.
Show your calculations under the PE Multiple approach and Earning Growth model.
Hint: 1.Assume given EPS is of Year 0 2.Assume ROE to be Ke
Solution:
5(1  .02)
(i)Present Value of the stock = = ` 63.75
5
.10  .02
(ii)Value of stock under the PE Multiple Approach
Actual Stock Price 40.00
Return on equity 8%
EPS 3.00
PE Multiple (1/Return on Equity) = 1/ 8% 12.50 times
Market Price per Share 37.50
Comment: Since, Actual Stock Price is higher, hence it is overvalued.
(iii)Value of the Stock under the Earnings Growth Model
Actual Stock Price 40.00
Return on equity 8%
EPS 3.00
Growth Rate 2%
EPS(1  g) 3(1  .02)
Market Price per Share = = ` 51.00
Ke  g .08  .02
Comment: Since, Actual Stock Price is lower, hence it is undervalued.
QUESTION NO.15C Following information is available for M/s. ABC Ltd.

Current dividend ` 2.50 per share Discount Rate 10.5 %
Growth rate 2%
(i)Calculate the present price of the share of ABC Ltd.
(ii)Is its stock overvalued, if stock price is ` 35, ROE 9% and EPS ` 2.25.
Solution:
2.50(1.02)
(i)Present Value of the stock of ABC Ltd. Is:- Vo = = ` 30/-.
0.105  0.02
(ii)Value of stock under the PE Multiple Approach
Particulars
Return on equity 9%
EPS ` 2.25
PE Multiple (1/Return on Equity) = 1/9% 11.11
Market Price per Share ` 25.00
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Since, Actual Stock Price is higher, hence it is overvalued.

OR
Value of the Stock under the Earnings Growth Model
Particulars
Return on equity 9%
EPS ` 2.25
Growth Rate 2%
Market Price per Share [EPS x (1 + g)]/(Ke - g) ` 32.79
= ` 2.25 x 1.02/0.07
Since, Actual Stock Price is higher, hence it is overvalued.
VALUE AT THE END OF “N” YEARS FROM WHERE GROWTH RATE BECOMES CONSTANT :
QUESTION NO.16A(RTP) X Ltd., just declared a dividend of ` 12.50 per share. Mr. A is planning to purchase the
share of X Ltd. because he is of the opinion that growth rate will increase to 8% for next three years. Further, he
expects to sell the share at ` 400 at year end 3. You are required to determine:
(a)Calculate Fair Price Per Share, if he requires a rate of return of 12%.
(b)Calculate Fair Price Per Share if he is of the opinion that the 8% growth rate can be maintained indefinitely and
require 12% return?
(c)Suppose that 8% growth rate is achieved with 12% rate of return, what will be price of share at the end of 3
year.(i.e Calculate P3)
Solution:
(a)Expected dividend for next 3 years
Year 1 (D1) ` 12.50 (1.08) = `13.50; Year 2 (D2) Rs. 13.50 (1 + .08) = `14.58
Year 3 (D3) ` 14.58 (1 + .08) = `15.75; Required rate of return = 12% (Ke)
Market price of share after 3 years = ` 400
13.50 14.58 15.75 400
The present value of share P0 =   
(1  .12)1 (1  .12)2 (1  .12)3 (1  .12)3
P0 = 13.50 x 0.893 + 14.58 x 0.797 + 15.75 x 0.712 + 400 x 0.712 = 12.06 + 11.62 + 11.21 + 284.80 = Rs.319.69
(b)If growth rate 8% is achieved for indefinite period, then maximum price of share should Mr. A willing be
13.50
to pay is: P0 = = ` 337.50
.12 – .08
(c)Assuming that conditions mentioned above remain same, the price expected after 3 years will be:
D4 15.75(1  .08)
P3 = = = ` 425.25
Ke – g .12 – .08
QUESTION NO.16B S Corporation, a manufacturer of do-it-yourself hardware and housewares, reported earnings
per share of € 2.10 in 2003, on which it paid dividends per share of €0.69. Earnings are expected to grow 15% a
year from 2003 to 2008, during which period the dividend payout ratio is expected to remain unchanged. After
2008, the earnings growth rate is expected to drop to a stable 6%, and the payout ratio is expected to increase to
65% of earnings. The firm has a beta of 1.40 currently, and is expected to have a beta of 1.10 after 2008. The
market risk premium is 5.5%. The Treasury bond rate is 6.25%.
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(a)What is the expected price of the stock at the end of 2008?

(b)What is the value of the stock as on today,using the two-stage dividend discount model? [Cover This Part
After Chapter: Business Valuation Concept: When Two Discount Rate is Used; Question No:5]
Solution:
Working Note : Calculation Of Dividend At The End Of Each Year
Years EPS DPS
0(2003) 2.10 0.69 Payout Ratio = .69 / 2.10 = 32.86%
1(2004) 2.42 0.794
2(2005) 2.78 0.913
3(2006) 3.20 1.048
4(2007) 3.68 1.206
5(2008) 4.22 1.387
6(2009) 4.47 2.91 Payout Ratio is 65% as stated in question
Calculation Of Ke: Ke upto 2008 = 0.0625 + 1.4(0.055) = 13.95%; Ke after 2008 = 0.0625 + 1.1(0.055) = 12.3%
DPSYear 2009 2.91
(a)Expected price of the stock at the end of 2008 = = = €46.19
Ke  g .123 - .06
(b)Current price or value of the stock as on today =
.794 .913 1.048 1.206 1.387 1  2.91 
P0 =       = €27.54
(1  .1395)1 (1  .1395)2 (1  .1395)3 (1  .1395)4 5 5
(1  .1395) (1  .1395)  .123  .06 
QUESTION NO.16C (8 Marks)(Mock Test Papers) A company had paid a dividend of ` 2.50 per share last year
and its required rate of return for equity investors is 20%. What will be the market price of the share , if
(i)there is no growth in dividend ? (ii)dividend grows at constant rate of 5% per annuam in perpetuity? (iii)constant
dividend for first five years and then grows at constant rate of 5% per annuam in perpetuity? (iv)constant dividend
for first five years and then share is sold at the price of ` 20?
Solution:
(i)If there is no growth in Dividend then market price of share should be: Po = ` 2.50/ 0.20 = ` 12.50
(ii)If there is growth in Dividend @ 5% p.a. then market price of share should be:
Po = Do(1 + g)/Ke - g = 2.50(1 + .05)/(0.20 - 0.05) = ` 17.50
(iii)If constant dividend for first 5 years and thereafter Dividend grows @ 5% p.a.then market price of share
should be: Po = PV of Constant Dividend for first 5 years + PV of Share after 5 years with constant growth of
dividend in perpetuity or Po = PVAF (20%, 5) x ` 2.50 + PVF (20%, 5) x ` 2.50 (1 + 0.05)/(0.20 - 0.05) or Po = ` 14.52
(iv)If constant dividend for first 5 years and thereafter share is sold at ` 20, then market price of share
should be: Po = PV of Constant Dividend for first 5 years + PV of Share after 5 years or Po = PVAF (20%, 5) x ` 2.50
+ PVF (20%, 5) x ` 20 or Po = 2.991 x ` 2.50 + 0.402 x ` 20 = ` 15.52
QUESTION NO.16D(Study Material) X Limited, just declared a dividend of ` 14.00 per share. Mr. B is planning to
purchase the share of X Limited, anticipating increase in growth rate from 8% to 9%, which will continue for three
years. He also expects the market price of this share to be ` 360.00 after three years.
You are required to determine: (i)the maximum amount Mr. B should pay for shares, if he requires a rate of
return of 13% per annum. (ii)the maximum price Mr. B will be willing to pay for share, if he is of the opinion that
the 9% growth can be maintained indefinitely and require 13% rate of return per annum. (iii)the price of share at
the end of three years, if 9% growth rate is achieved and assuming other conditions remaining same as in (ii)
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above.Calculate rupee amount up to two decimal points.

Year-1 Year-2 Year-3
FVIF @ 9% 1.090 1.188 1.295
FVIF @ 13% 1.130 1.277 1.443
PVIF @ 13% 0.885 0.783 0.693
Solution:
(i)Expected dividend for next 3 years
Year 1 (D1) ` 14.00 (1.09) = ` 15.26; Year 2 (D2) ` 14.00 (1.188) = ` 16.63
Year 3 (D3) ` 14.00 (1.295) = ` 18.13
Required rate of return = 13% (Ke); Market price of share after 3 years (P3) = ` 360
15.26 16.63 18.13 360
The present value of share P0 =   
(1  .13)1 (1  .13)2 (1  .13)3 (1  .13)3
P0 = 15.26(0.885) + 16.63(0.783) + 18.13(0.693) + 360(0.693) = ` 288.56
(ii)If growth rate 9% is achieved for indefinite period, then maximum price of share which Mr. A should be
15.26
willing to pay is P0 = = ` 381.50
.13 – .09
(iii)Assuming that conditions mentioned above remain same, the price expected after 3 years will be:
D4 18.13(1  .09)
P3 = = = ` 494.00
Ke – g .13 – .09
QUESTION NO.16E ABC Limited, just declared a dividend of ` 28.00 per share. Mr. A is planning to purchase the
share of ABC Limited, anticipating increase in growth rate from 8% to 9%, which will continue for three years. He
also expects the market price of this share to be ` 720.00 after three years. You are required to determine:
(i)the maximum amount Mr. A should pay for shares, if he requires a rate of return of 13% per annum.
(ii)the maximum price Mr. A will be willing to pay for share, if he is of the opinion that the 9% growth can be
maintained indefinitely and require 13% rate of return per annum. (iii)the price of share at the end of three years,
if 9% growth rate is achieved and assuming other conditions remaining same as in (ii)above.
Note: Calculate rupee amount up to two decimal points and use PVF upto 3 decimal points.
Solution:
(i)Expected dividend for next 3 years.
Year 1 (D1): ` 28.00 (1.09) = ` 30.52; Year 2 (D2): ` 28.00 (1.09)2 = ` 33.27; Year 3 (D3): ` 28.00 (1.09)3 = ` 36.26
Required rate of return = 13% (Ke); Market price of share after 3 years = (P3) = ` 720
D1 D2 D3 P3
The present value of share P0 = + + +
(1  Ke) (1  Ke)2 (1  Ke) (1  Ke)3
3
30.52 33.27 36.26 720

P0 = + + + = 30.52(0.885) + 33.27(0.783) + 36.26(0.693) + 720(0.693) =
(1  0.13) (1  0.13)2 (1  0.13)3 (1  0.13)3
27.01 + 26.05 + 25.13 + 498.96 = ` 577.15
(ii)If growth rate 9% is achieved for indefinite period, then maximum price of share should Mr. A willing be
D1 30.52 30.52
to pay is P0 = = = = ` 763
(Ke  g) 0.13  0.09 0.04
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(iii)Assuming that conditions mentioned above remain same, the price expected after 3 years will be:
D4 D3 (1.09) 36.26 x 1.09 39.52
P3 = = = = = ` 988
(Ke  g) 0.13  0.09 0.04 0.04
QUESTION NO.16F M/s. B Ltd. has declared dividend of ` 2.50 per share on the EPS of ` 7. Earnings of the
company are expected to grow at the rate of 10% for the next 3 years and to be stabilized at 3% thereafter. The
pay-out ratio is expected to remain at the same level during 3 years and then will increase to 60%. If required rate
of return is 16% calculate:
(i)The current price of the share. (ii)The expected price of share of B Ltd. At the end of 3rd year.
Following table may be used for calculations.
Present Values t1 t2 t3 t4 t5
PVIF0.16,t 0.862 0.743 0.641 0.553 0.477
Solution:
Working Notes:
Period EPS Dividend
1 7.70 2.750
2 8.47 3.025
3 9.317 3.327
4th onwards 9.60 5.76
(i)Current price of the Share = PV of Dividends upto 3 Years + PV of Expected price of share of at the end of 3rd
5.76
year; Expected price of share of B Ltd. at the end of 3rd year = = ` 44.31
0.16 - 0.03
Accordingly, Current Market Price of Share shall be: = 2.750 x 0.862 + 3.025 x 0.743 + 3.327 x 0.641 + 44.31 x
0.641 = 2.371 + 2.248 + 2.133 + 28.403 = ` 35.155 say ` 35.16
5.76
(ii)Expected price of share of B Ltd. at the end of 3rd year = = ` 44.31
0.16 - 0.03
QUESTION NO.16G Current forecasts are for XYZ Company to pay dividends of `3, `3.24, and `3.50 over the next
three years, respectively. At the end of three years you anticipate selling your stock at a market price of `94.48.
What is the price of the stock given a 12% expected return?
Solution:
3.00 3.24 3.50  94.48
PV =   = `75.
(1  0.12)1 (1  0.12)2 (1  0.12)3
QUESTION NO.16H Chandra Chemicals earned `7.00 per share during the last year and paid a dividend of `2.50
per share. The earnings were expected to grow @10% for the next 3 years and thereafter stabilize at 3%. The
payout ratio is expected to remain at the same level during the three years and then increase to 60%. If the
required rate of return is 16%, compute.
(a) The expected price of the share at the end of third year.(b) The current price of the stock
Employ the two-stage dividend growth model.
Solution:
(a) We compute the expected EPS, expected DPS at the end of the third year.
Expected EPS at the end of fourth year = 7(1.10)3 (1.03) = `9.60
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Expected DPS at the end of fourth year = (9.60) (0.60) = `5.76

Given that the required rate of return is 16%. Therefore, the expected share price at the end of third year will be
DPS in the fourth year 5.76
given by: P3    `44.31
kg 0.16  0.03
(b) The dividends are obtained as follows on the assumption that DPS also grows at the same rate at which the
EPS grows.
Year DPS (`)
1 2.50 (1.10) = 2.75
2 2.75 (1.10) = 3.03
3 3.03 (1.10) = 3.33
2.75 3.03 3.33 44.31
P0     = 2.37 + 2.25 + 2.13 + 28.39 = ` 35.14
(1.16) (1.16)2 (1.16)3 (1.16)3
QUESTION NO.16I AB Ltd. is expected to pay a dividend of `4.00 at the end of first year, a dividend of `7.00 at the
end of second year, a dividend of `11.00 at the end of 3rd year. From 4th year onwards, the dividends are
expected to grow at a constant growth rate of 4%. If the required rate of return is 14%, compute the present value
of the stock.
Solution:
4 7 11 11.44
P0    
(1.14) (1.14)2 (1.14)3 (1.14)3 (0.14  0.04)
Therefore, the price of the share is ` 93.54 through DDM (dividend discount model)
QUESTION NO.16J (a) A Ltd’s earnings per share is `10 and growth rate of earning is 4%. The earnings growth
rate is expected to stay at this level in the near future. If its payout ratio is 55% and the cost of capital is 15%,
what is the current market price of the share?
(b) What will be the price of the above-mentioned stock after three years?
Solution:
(a) Given, current EPS = `10; earnings growth rate = 4%; pay-out ratio = 55%, required rate of return = 15%. If we
10(1.04)(0.55)
substitute the values in the equation, we have P0 = (0.15 - 0.04) = `52
10(1 + 0.04)4 (0.55)

(b) The price after 3 year is computed as follows: P3 = = `58.49
(0.15 - 0.04)
The price after 3 years will be `58.49
QUESTION NO.16K Akai Ltd’s latest annual dividend of `1.25 a share was paid yesterday and maintained its
historic 7% annual rate of growth. You plan to purchase the stock today because you believe that the dividend
growth rate will increase to 8% for the next three years and the selling price of the stock will be `40.00 per share
at the end of that time.
(a) How much should you be willing to pay for the share if you require a 12% return?
(b) What is the maximum price you should be willing to pay for the stock if you believe that the 8% growth rate
can be maintained indefinitely and you require a 12% return?
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(c) If the 8% rate of growth is achieved, what will be the price at the end of year 3, assuming the conditions in part
(b)?
Solution:
(a) Projected dividends for next 3 years:
Year 1 (`1.25 x 1.08) = `1.35 Year 2 (`1.35 x 1.08) = `1.46 Year 3 (`1.46 x 1.08) = `1.58
Required rate of return = 12% Growth rate of dividends = 8%
1.35 1.46 1.58 40
The present value of stock is:V =    = 1.21 + 1.16 + 1.12 + 28.47 = ` 31.96
1.12 (1.12)2 (1.12)3 (1.12)3
1.35 1.35
(b) Growth rate = 8% ; Required rate of return = 12% ; V    `33.75
0.12  0.08 0.04
(c) Assuming all the above assumption remain the same, the price at the end of year 3 will be:
D4 1.25 x (1.08)4 1.25 x 1.3605

P3     `42.52
kg 0.12  0.08 0.04
QUESTION NO.16L (Study Material) Share of X Ltd. is expected to be sold at 36 with a dividend of 6 after one
year. If required rate of return is 20% then what will be the share price?
Solution:
6 36
The expected share price shall be computed as follows: P0 =  = 35
(1  0.20)1 (1  0.20)1
CALCULATION OF NPV DUE TO INVESTMENT
QUESTION NO.17A (Exam Question)(8 Marks) DEF Ltd has been regularly paying a dividend of ` 19,20,000 per
annum for several years and it is expected that same dividend would continue at this level in near future. There
are 12,00,000 equity shares of ` 10 each and the share is traded at par. The company has an opportunity to invest
` 8,00,000 in one year’s time as well as further ` 8,00,000 in two year’s time in a project as it is estimated that
the project will generate cash inflow of ` 3,00,000 per annum in three year’s time and four year’s time and `
3,60,000 in five year’s time which will continue forever. This investment is possible if dividend is reduced for next
two years. Whether the company should accept the project? Also analyze the effect on the market price of the
share, if the company decides to accept the project.
Solution:
Calculation of NPV
 3,00,000 3,00 ,000 3,60 ,000 3,60 ,000 3,60,000   8 ,00,000 8,00,000 
=       .......... -  
1 (1  .16)2 
 (1  .16)3 (1  .16)4 (1  .16)5 (1  .16)6 (1  .16)7   (1  .16) 
3,00,000 3,00,000 1 3,60,000 3,60,000  

=   [ + + ...∞ ] -  8 ,00,000  8,00,000 
1 2
(1  .16)3 (1  .16)4 (1  .16)4 (1 + .16) (1 + .16)  (1  .16)1 (1  .16)2 
3,00,000 3,00,000
 
1  3,60,000   8 ,00,000 8,00,000 
=   -  
(1  .16)3 (1  .16)4 (1  .16)4  .16   (1  .16)1 (1  .16)2 
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= [3,00,000 x .641 + 3,00,000 x .552 + .552 x 22,50,000] - [8,00,000 x .862 + 8,00,000 x .743] = + ` 3,15,900
Decision: Since NPV is positive, We should accept the project.
3,15,900
Effect on Market Price: Revised MPS = 10 + =10.26;
12,00,000
Due be investment, MPS will increase from `10 to `10.26
DPS 1.6
Working Note: Ke Calculation (Dividend Price Approach): Ke= = = 16%
MPS 10
QUESTION NO.17B(Exam Question)(8 Marks) Vinay Ltd. has been regularly paying a dividend of ` 15,00,000
p.a. for several years. It is expected that dividend would continue at this level in near future. There are 10 lakhs
equity shares of ` 10 each (being traded at par). The company has an opportunity to invest 10,00,000 at year end
1 and a similar amount in two year's end time in a project that will generate an equal cash flow of ` 4,00,000 p.a
forever starting from three year’s end. The only possible way of financing this investment is by paying a reduced
dividend for the next two years to the shareholders.
Analyse the effect on the market price of the share, if the company decides to go ahead with the project.
Solution:
Total Current Market Value (Po) : 10 lakh shares @ ` 10 = 100 lakhs
Annual receipts of dividend by investors in equity every year = 15 lakhs
15 Lakhs DPS 1.5
Dividend Per Share = = ` 1.5; P0   10   Ke  15% [Dividend Yield Method]
10 Lakhs Ke Ke
To evaluate the impact of the project on market price of shares of the company we will calculate the NPV and
divide it with No. of shares.
Computation of NPV: Net Present Value = Present Value of Inflows - Present Value of Outflows
 4,00,000 4,00,000 4,00,000   10,00,000 10,00,000 
=     ........α   
3 (1  .15)4 (1  .15)5 1 (1  .15)2 
 (1  .15)   (1  .15) 
1  4,00,000 4,00,000 4,00,000   10,00,000 10,00,000 

=     ........α   
(1  .15)2  (1  .15)1 (1  .15)2 (1  .15)3   (1  .15)1 (1  .15)2 
1  4,00,000   10,00,000 10,00,000 

=     = (+) 3,90,674
(1  .15)2  .15   (1  .15)1 (1  .15)2 
3,90 ,674
Increased NPV Per Share = = ` 0.39 approx.
10,00,000
Suggestion: Hence MPS will increase by .39 if the company decides to go ahead with the project. Hence the new
MPS will be ( 10 + .39 ) = ` 10.39
CALCULATION OF DIVIDEND DUE TO INVESTMENT
QUESTION NO.18 (Exam Question)(8 Marks) Rahim Enterprises is a manufacturer and exporter of woolen gar-
ments to European countries. Their business is expanding day by day and in the previous financial year the
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company has registered a 25% growth in export business. The company is in the process of considering a new
investment project. It is an all equity financed company with 10,00,000 equity shares of face value of ` 50 per
share. The current issue price of this share is ` 125 ex-divided. Annual earning are ` 25 per share and in the
absence of new investments will remain constant in perpetuity. All earnings are distributed at present. A new
investment is available which will cost ` 1,75,00,000 in one year’s time and will produce annual cash inflows
thereafter of ` 50,00,000. Analyse the effect of the new project on dividend payments and the share price.
Solution:
DPS 25
(i)Let us first compute the Cost of Equity Ke = = =20%
P0 125
(ii)Current Earning = ` 25 x 10,00,000 = ` 2,50,00,000
The new project can be financed by retaining ` 1,75,00,000 of ` 2,50,00,000 earning next year, reducing dividend
payment to ` 75,00,000/10,00,000 = ` 7.50
(iii)In the following year, dividend will increase due to the cash generated by the new project.
250 ,00 ,000  50 ,00,000
Dividend per share in year 2 shall be: = ` 30 per share
10 ,00 ,000
(iv)The new share price can be calculated by finding the Present Value of the revised dividend payments:
7.5 30  1 
  = ` 131.25 per share
1.20 .20  1  .20 
CALCULATION OF NPV IN CASE OF SHARE INVESTMENT
QUESTION NO.19A (Study Material) Mr. A is thinking of buying shares at ` 500 each having face value of ` 100.
He is expecting a bonus at the ratio of 1:5 during the fourth year*. Annual expected dividend is 20% and the same
rate is expected to be maintained on the expanded capital base. He intends to sell the shares at the end of
seventh year at an expected price of ` 900 each. Incidental expenses(Brokerage) for purchase and sale of shares
are estimated to be 5% of the market price. He expects a minimum return of 12% per annum.
(a)Should Mr. A buy the share? (b)If so, what maximum price should he pay for each share?
*Hint: i.e. after 3 years
Solution:
(a)Present Value of dividend stream and sales proceeds
Years Divdend /Sale PVF (12%) PV (`)
1 ` 20 0.893 17.86
2 ` 20 0.797 15.94
3 ` 20 0.712 14.24
4 ` 24 0.636 15.26
5 ` 24 0.567 13.61
6 ` 24 0.507 12.17
7 ` 24 0.452 10.85
7 ` 1026 (` 900 x 1.2 x 0.95*) 0.452 463.75_
` 563.68
Less : - Cost of Share (` 500 x 1.05**) ` 525.00
Net gain ` 38.68_
Since Mr. A is gaining ` 38.68 per share, he should buy the share.
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*deducting 5% issue expenses; **including 5% issue expenses

(b)Maximum price Mr. A should be ready to pay is ` 563.68 which will include incidental expenses.
563.68 x 100/105 = ` 536.84 excluding incidental expenses
QUESTION NO.19B Mr. X wants to buy shares of A Ltd. (having a Beta of 2) at current market price of ` 500 each
having face value of `100. He is expecting a bonus at the ratio of 1: 4 during the fifth year. Annual expected
dividend is 20% and the same rate is expected to be maintained throughout the holding period. He intends to sell
the shares at the end of 7th year and expect that the market price shall be doubled during this holding period.
Incidental expenses for purchase of shares are estimated to be 5% of the market price. The risk-free rate of return
and market rate of return are 5% and 7.50% respectively.
ADVISE Mr. X should buy this share or not. If so, then recommend the maximum price should he pay for each
share.
Note: Assume no tax on dividend income and capital gain.
Solution:
First, we shall compute the Cost of Equity using CAPM as follows: = 5% + 2(7.50% - 5.00%) = 10%
P.V. of dividend stream and sales proceeds
Year Divd. /Sale PVF (10%) PV (`)
1 ` 20/- 0.909 18.18
2 ` 20/- 0.826 16.52
3 ` 20/- 0.751 15.02
4 ` 20/- 0.683 13.66
5 ` 25/ 0.621 15.53
6 ` 25/ 0.564 14.10
7 ` 25/ 0.513 12.83
7 ` 1250/- (` 1000 x 1.25) 0.513 641.25
747.09
Less: Cost of Share (` 500 x 1.05) ` 525.00
Net gain ` 222.09
Since Mr. X is gaining ` 222.09 per share, he should buy the share. Maximum price Mr. A should be ready to pay
is ` 747.09.
CALCULATION OF PE RATIO USING GROWTH MODEL
QUESTION NO.20A(8 Marks) A company has an EPS of ` 2.5 for the last year and the DPS of ` 1. The earnings is
expected to grow at 2% a year in long run. Currently it is trading at 7 times its earnings. If the required rate of
return is 14%, compute the following: (i)An estimate of the P/E ratio using Gordon growth model. (ii)The Long-
term growth rate implied by the current P/E ratio.
Solution:
(i)Estimation of P/E Ratio using Gordon Growth Model: Ke = ( D1 / P) + g or 0.14 = [ 1(1.02)/P ] + 0.02 or P = `
8.50; So PE Ratio = MPSo/EPSo = ` 8.50 / ` 2.50 = 3.40
(ii)Long Term Growth Rate implied: Based on Current PE Ratio, the price per share = ` 2.50 x 7 Times = ` 17.50
; Now we know that P = D0 (1 + g)/ (ke - g) or ` 17.50 = ` 1(1 + g)/ (0.14 - g) or g = 0.0784 i.e. 7.84%
Note: Assumed Dividend Growth Rate to be same as Earning Growth Rate.
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QUESTION NO.20B A company has an EPS of `5 for the current year and a DPS of `2. The earnings growth rate
during the past four years was 4% and expected to grow at 2% a year in the long run. Currently, it is trading at 7
times its earnings. If the required rate of return is 14%, compute the following.
(a) An estimate of the P/E ratio.
(b) The long-term growth rate implied by the current P/E ratio.
Solution:
(a) EPS current year = `2.00; expected growth rate = 2%; required rate of return = 14%
D (1  g) 2(1.02) 17 17
We know that: P0  0   17.00 P/E ratio    3.4
kg (0.14  0.02) EPS 5
D (1  g) P0  D0  (1  g)
(b) Again P0  0 ; Dividing throughout by EPS, we have  
kg E  E  kg
P  2  (1  g)
Given that 0  7 or 7    Solving, g = 0.078378 or 7.84%
E  5  (0.14  g)
CALCULATION OF PO TAKING BEFORE AND AFTER TAX
QUESTION NO.21 (Exam Question) Mr. A is contemplating purchase of equity shares of a Company. His expectation
of return is 10% before tax by way of dividend with an annual growth of 5%. Company’s last dividend was ` 2 per
share. Even as he is contemplating, Mr. A suddenly finds, due to a budget announcement dividends have been
exempted from tax in hands of the shareholders(recipients). But the imposition of Dividend Distribution
Tax(Corporate Dividend Tax) on the Company is likely to lead to a fall in dividend of 20 paise per share. A’s
marginal tax rate is 30%.
Calculate what should be Mr. A’s estimates of price per share before and after Budget announcement?
Solution:
2  (1  .05)
Now Market Price Per Share (Po) before Budget annoncement: Po = = `42
.10 – .05
1.80  (1  .05)
and Market Price Per Share (Po) after Budget announcement: Po = = ` 94.50
.07 – .05
DIVIDEND-WHEN GROWTH RATE IN DIVIDEND IS CALCULATED FROM GROWTH RATE IN EARNING
QUESTION NO.22A(RTP) Z Co. is a watch manufacturing company and is all equity financed and has paid up
capital `10,00,000 (`10 per shares). The other data related to the company is as follows:
Year EPS (`) Dividend Per Share (`) Share Price (`)
2004 4.20 1.70 25.20
2005 4.60 1.80 18.40
2006 5.10 2.00 25.50
2007 5.50 2.20 27.50
2008 6.20 2.50 37.20
Z Co. has hired one management consultant, Vidal Consultants about the future earnings and other related item
for the forthcoming years. As per Vidal Consultants’s report
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(1)The earnings and dividend will grow at 25% for the next two years.
(2)Earnings are likely at rate of 10% from 3rd year and onwards.
(3)Further if there is reduction in earnings growth occurs dividend payout ratio will increase to 50%
Calculate the estimated share price and Current P/E Ratio (taking Fair Po calculated by you and given current EPS)
which analysts now expect for Z Co., using the dividend valuation model. You may further assume that cost of
equity is 18%.
Solution:
3.13 3.91 5.33 5.33(1  .10) 5.33(1  .10)2

(a)Po =      .........
(1  .18)1 (1  .18)2 (1  .18)3 (1  .18)4 (1  .18)5
3.13 3.91 5.33 1  5.33(1  .10) 

Po       = 53.34
(1  .18)1 (1  .18)2 (1  .18)3 (1  .18)3  .18 - .10 
Additional Analysis: Why Dividend of Year 3 has been taken to be 5.33? Since it is clearly written in the question
that Payout Ratio changed to 50% in year 3 when there is reduction in earning growth rate.
How it has been calculated ?
Year EPS DPS
2009 7.75 3.13
2010 9.6875 3.91
2011 10.65625 5.33 [50 % D/P ratio,as it is written in question that, when growth rate in earning fall,
DP Ratio should be 50%. And we can clearly see that growth rate in earning is falling from second year i.e from 25
% to 10 % in third year. Now from 2011 i.e. 3rd year, DPS will grow at the rate of 10% upto infinity or we can say
that it is 50% of EPS.
2012 11.721875 5.863 or 5.33(1 + .10)
Market Price Per Share 53.34
(b)P/E Ratio: P/E Ratio = = = 8.60
Earning Per Share 6.20
QUESTION NO.22B(Exam Question)(6 Marks) X Ltd. is a Shoes manufacturing company. It is all equity financed
and has a paid-up Capital of ` 10,00,000 (` 10 per share) X Ltd. has hired Swastika consultants to analyse the
future earnings. The report of Swastika consultants states as follows:
(i)The earnings and dividend will grow at 25% for the next two years.
(ii)Earnings are likely to grow at the rate of 10% from 3rd year and onwards.
(iii)Further, if there is reduction in earnings growth, dividend payout ratio will increase to 50%.
The other data related to the company are as follows:
Year EPS Net Dividend per share Share Price
2010 6.30 2.52 63.00
2011 7.00 2.80 46.00
2012 7.70 3.08 63.75
2013 8.40 3.36 68.75
2014 9.60 3.84 93.00
You may assume that the tax rate is 30% (not expected to change in future) and post tax cost of capital is 15%.By
using the Dividend Valuation Model, Calculate (i)Expected Market Price per share (ii)P/E Ratio.
Solution:
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4.80 6.00 8.25 1  8.25(1  .10) 

(a)Expected MPS =      = 133.57
(1  .15)1 (1  .15)2 (1  .15)3 (1  .15)3  .15 - .10 
133.57
(b)P/E Ratio: = 13.91
9.60
Working Note: Calculation Of Dividend Of Each Year
Year EPS DPS
2015 12.00 (9.60 x 125%) 4.80 (3.84 x 125%)
2016 15.00 (12.00 x 125%) 6.00 (4.80 x 125%)
2017 16.50 (15.00 x 110%) 8.25*(50% of ``16.50)
2018 18.15 9.07 or 8.25 (1 + .10)1 or (50% of `18.15)
*Payout Ratio changed to 50%
Note: Since Net DPS word is used its means "DPS is already after tax".
CALCULATION OF MARKET PRICE ON THE BASIS OF PE RATIO FORECAST
QUESTION NO.23 You are interested in buying some equity stocks of RK Ltd. The company has 3 divisions
operating in different industries. Division A captures 10% of its industries sales which is forecasted to be ` 50
crore for the industry. Division B and C captures 30% and 2% of their respective industry’s sales, which are
expected to be ` 20 crore and ` 8.5 crore respectively. Division A traditionally had a 5% net income margin,
whereas divisions B and C had 8% and 10% net income margin respectively. RK Ltd. has 3,00,000 shares of equity
stock outstanding, which sell at ` 250. The company has not paid dividend since it started its business 10 years
ago. However from the market sources you come to know that RK Ltd. will start paying dividend in 3 years time
and the pay-out ratio is 30%. Expecting this dividend, you would like to hold the stock for 5 year. By analysing the
past financial statements, you have determined that RK Ltd. ‘s required rate of return is 18% and that P/E ratio of
10 for the next year and on ending P/E ratio of 20 at the end of the fifth year are appropriate. Required:
(i)Would you purchase RK Ltd. equity at this time based on your one year forecast?
(ii)If you expect earnings to grow @ 15% continuously, how much are you willing to pay for the stock of RK Ltd ?
Ignore taxation. PV factors are given below:
Years 1 2 3 4 5
PVIF@ 18% 0.847 0.718 0.609 0.516 0.437
Solution:
Working Notes: Computation of Earning Per Share (EPS)
Particulars Amount (`)
Margin of Division A (` 50 crore x 10% x 5%) 25,00,000
Margin of Division B (` 20 crore x 30% x 8%) 48,00,000
Margin of Division C (` 8.5 crore x 2% x 10%) 1,70,000
74,70,000
No. of Equity Shares 3,00,000
EPS ` 24.90
(i)Market price based on one year forecast: Expected market price at the end of the year = ` 24.90 x 10 = ` 249
PV of the Expected Price = ` 249 x 0.847 = ` 210.90
Decision: I would NOT like to purchase the share as the expected market price of shares is less than its current
price of ` 250
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(ii)If Earning is expected to grow @ 15%:

Year EPS (`) Dividend (`) PVF@18% PV (`)
0 ` 24.90*
1 28.64 — 0.847 —
2 32.93 — 0.718 —
3 37.87 11.36 0.609 6.92
4 43.55 13.07 0.516 6.74
5 50.08 15.02 0.437 6.56_
20.22
15.02(1.15)
Share Price after 5 years = = ` 575.77; PV of the Market Price after 5 years = ` 575.77 x 0.437 = `
0.18-0.15
251.61; Total PV of Inflows = ` 20.22 + ` 251.61 = ` 271.83
Decision: Thus, the maximum price I would be willing to pay for the share shall be ` 271.83.
*Assuming EPS of ` 24.90 belongs to Year 0.
Additional Analysis: Ending P/E ratio of 20 which is at the end of the fifth year is of no use for the given solution.
Hence ignored.
SUSTAINABLE GROWTH RATE (SGR) USING VARIOUS RATIOS
QUESTION NO.24 AB Industries has Equity Capital of ` 12 Lakhs, total Debt of ` 8 Lakhs, and annual sales of ` 30
Lakhs. Two mutually exclusive proposals are under consideration for the next year. The details of the proposals
are as under:
Particulars Proposal no. 1 Proposal no. 2
Target Assets to Sales Ratio 0.65 0.62
Target Net Profit Margin (%) 4 5
Target Debt Equity Ratio (DER) 2:3 4:1
Target Retention Ratio (of Earnings) (%) 75 -
Annual Dividend (` In Lakhs) - 0.30
New Equity Raised (` in Lakhs) - 1
You are required to calculate sustainable growth rate for both the proposals.
Solution:
Sustainable Growth Rate under Proposal 1
Sales (Given) = ` 30 Lakhs; Total Assets = ` 30 Lakhs x 0.65 = ` 19.50 Lakhs; Net Profit = ` 30 Lakhs x 4% = ` 1.20
Lakhs; Now ROE = Net Profit Margin x Total Assets Turnover Ratio x Equity Multiplier [Taken from IPCC/Inter FM-
Sales Equity 30 Lakhs 12 Lakhs
RATIO Analysis] = .04 x x = .04 x x = 3.69%
9%
Total Assets Equity  Debt 19.50 Lakhs 12 Lakhs  8 Lakhs
Sustainable Growth Rate = Retention Ratio x ROE = b x r = 0.75 x 3.69% = 2.77%
Sustainable Growth Rate under Proposal 2
New Equity = ` 12 Lakhs + ` 1 Lakh = ` 13 Lakhs; New Debt = ` 13 Lakhs x 4 = ` 52 Lakhs
Total Assets = Equity + Debt = ` 13 Lakhs + ` 52 Lakhs = ` 65 Lakhs
Target Assets to Sales Ratio (Given) = 0.62; Sales = ` 65 Lakhs / 0.62 = ` 104.84 Lakhs
Net Profit = ` 104.84 Lakhs x 5% = ` 5.242 Lakhs; Now ROE = Net Profit Margin x Total Assets Turnover Ratio x
Equity Multiplier [Taken from IPCC/Inter FM-RATIO Analysis]
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Sales Equity 104.84 13 Lakhs

= .05 x x = .05 x x = 1.613%
Total Assets Equity  Debt 65 13 Lakhs  52 Lakhs
Sustainable Growth Rate = Retention Ratio x ROE = b x r = 0.943 x 1.613% = 1.52%
5.242 Lakhs  0.30 Lakhs
Retention Ratio = = 0.943
5.242 Lakhs
CALCULATION OF NEW D1 WHEN GROWTH RATE CHANGES
QUESTION NO.25 In December, 2011 AB Co.’s share was sold for `146 per share. A long term earnings growth
rate of 7.5% is anticipated. AB Co. is expected to pay dividend of ` 3.36 per share.
(i)What rate of return an investor can expect to earn assuming that dividends are expected to grow along with
earnings at 7.5% per year in perpetuity?In short calculate Ke.
(ii)It is expected that AB Co. will earn about 10% on book Equity and shall retain 60% of earnings. In this case,
whether, there would be any change in growth rate and cost of Equity?
Solution:
(i)Calculation Of Cost of Equity-
D 3.36
As Per Growth Model: Ke = 1  g =  .075 = 0.0230 + 0.075 = 0.098 or 9.80%
P0 146
(ii)Calculation Of New Growth Rate-
Rate of Return on Retained Earnings (r) 10% and Retention Ratio (b) = 60%,
New Growth Rate will be as follows: g = b x r i.e. = 0.10 x 0.60 = 0.06 or 6%
5.376
Calculation Of New Cost of Equity- New Ke =  .06 = 9.68%
146
Working Notes: Calculation Of New D1- Hint: First Calculate EPS at year end 1
Old D1 Data: r = 10% [assuming that rate of return on retained earnings (r) is same under both situation]
g = 7.5%; b = 0.75 [0.075 = b x 0.10]; therefore payout ratio = 0.25 with D1 = 3.36, EPS will be 3.36/0.25 = 13.44
New D1 Data: r = 10%; payout ratio = .40; EPS = 13.44 [assuming EPS same.]
With new 0.40 payout ratio the new dividend will be D1 = 13.44 x 0.40 = 5.376
FORM OF MARKET IN CASE OF UNDERVALUED SHARES
QUESTION NO.26 The following information pertains to Golden Ltd:

Profit before tax ` 75 crore Tax rate 30%
Equity capitalization rate 15% Return on investment (ROI) 18%
Retention ratio 80% Number of shares outstanding 75,00,000
The market price of the share of the company in the bull market was somewhere around ` 2100 per share. Advice,
whether the share of the Golden Ltd. should be purchased or not. Further, also suggest the form of Market
prevalent as per EMH Theory. Note: Use Gordon’s Growth Model.
Solution:
E(1  b)
Gordon’s Formula: P0 = Where, P0 = Market price per share; E = Earnings per share (` 52.50 crore /
K  br
75,00,000) = ` 70; K = Cost of Capital = 15%; b = 80%; D = ` 70 x 0.20 = `14; r = IRR = 18%; br = Growth Rate (0.80
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70(1  0.80) 14
x 18%) = 14.4%; P0 = = = ` 2333.33
0.15  0.144 0.006
Advice: Despite the fact that market price of share of the company during bull was around ` 2100, it is worth to
purchase the same as intrinsic value of share is higher than market price even in bull phase. The form of market
is weak form of market as it is not discounting all information.
Note: EPS is normally assumed as EPS 1 in this type of question
CALCULATION OF PO USING GROWTH MODEL WHEN G > KE
QUESTION NO.27A A share of Tension-free Economy Ltd is quoted at a price earnings ratio of 7.5 times. The
retained earning being 37.5% is ` 3 per share. Calculate
(i)The company’s cost of equity, if rate of return is on retained earning is 12%.
(ii)Market price of share, if anticipated growth rate is 13% per annum with same cost of equity.
(iii)Market price per share, if the company’s cost of capital is 18% and anticipated growth rate is 15% per annum,
assuming other conditions remaining the same.
Solution:
(i)Calculation of Cost of Capital: g = b x r or g = 0.375 x 12% = 4.5%
Retained earnings 37.5% ` 3 per share
Dividend* 62.5% ` 5 per share
EPS 100.0% ` 8 per share
P/E Ratio 7.5 times
EPS(1  b) 8(1  .375)
Market price is ` 7.5 x 8 = ` 60 per share; P0  or 60  or Ke = 12.83%
Ke  g Ke  .045
(ii)With the growth rate given (13%) the Market price of share shall become negative,which is not possible.
Tutorial Note: Since the given question is based on Growth Model, other models should not be preferred.
8(1  .375)
(iii) P0  = ` 166.66 per share
.18  .15
QUESTION NO.27B A company has invested ` 500 lakhs in assets. There are 50 lakh shares outstanding. The par
value per share is ` 10. It earns a rate of 15% on its investment and has a policy of retaining 50% of the earnings.
If Ke is 10% what is the price of its share using the Gordon's model. What will happen to the price of the share if
the company is retaining 80% or 20% of its earnings ?
Solution:
EPS(1  b)
As per Gordon's Model we know that P0 
Ke  b  r
Retention Ratio Calculation Market Price
1.5(1  0.50)
(i) 50% P0  30
0.10  .5  .15
1.5(1  0.80)
(ii) 80% P0  Note
0.10  .8  .15
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1.5(1  0.20)
(iii) 20% P0  17.14
0.10  .20  .15
Note: The answer in case of (ii) is indeterminable as Ke < g and Gordon's Model wont work in this situation. In
other words when Ke is less than g, growth model will not be applicable.
Total Earnings 15% of Rs.500,00,000
Working Notes: Earning Per Share (EPS)   =1.5
Total Number Of Equity Share 50,00,000
DIVIDEND YIELD APPROCH
QUESTION NO.28 India Incorporated currently pays a dividend of `10 per share and it will be constant during the
life time of the corporation or in perpetual time. If the required rate of return of the investor is 14% a year, what
will be the value of the stock using zero growth rate model?
Solution:
D 10
V 0  0 or  ` 71.43
k 0.14
ADDITIONAL SALES AND MAXIMUM SALES THAT CAN BE ACHIEVED WITHOUT FURTHER BORROWINGS
QUESTION NO.29 Mr. X has submitted the following data:

Particulars (`) in Lakhs
Total Assets 250
Total Liabilities 220
Net Income 12
Dividend Paid 4.5
Sales 100
Mr. X wants to know to what extent sales can be increased without going for additional borrowings by using
Sustainable Growth Rate (SGR) concept ?
Solution:
Particulars Amount in ` Lakhs
(a)Total Assets 250.00
(b)Total Liabilities 220.00
(c)Net Income 12.00
(d)Dividend Paid 4.50
(e)Sales 100.00
(f)Equity (a) - (b) 30.00
(g)Return on Equity (ROE) (c) /(f) 40.00%
(h)Dividend pay-out Ratio (d) /(c) 37.50%
(i)SGR [g x (1 - h)] 25.00%*
(j)Additional Sales can be achieved without further borrowings (e) * (i) 25.00
(k)Maximum sales can be achieved without further borrowings (e) + (j) 125.00
OPTIMUM DIVIDEND AS PER WALTER’S MODEL [COVERED IN INTER SYLLABUS]
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QUESTION NO.30 Sahu & Co. earns ` 6 per share having capitalization rate of 10 % and has a return on investment
at the rate of 20 %. (i) According to Walter’s Model, what should be the price per share at 30 % dividend payout
ratio? (ii) Is this the optimum payout ratio as per Walter?
Solution:
r .2
(EPS – DPS) (6 – 1.8)
DPS Ke 1.8 .1
As per Walter Model we know that Po =  =  = Rs.102
2
Ke Ke .1 .1
Decision: This is not the optimum payout ratio because Rate of Return (r) is greater than Cost of Equity (Ke) and
therefore Po (Market price of the share ) can further go up if payout ratio is reduced. Hence in this case optimum
dividend payout ratio should be 0 % and not 30 % as given in question.
r .2
(EPS – DPS) (6 – 0)
DPS Ke 0 .1
Proof: Po at 0 % Dividend Payout Ratio =  =   Rs.120
Ke Ke .1 .1
Hence we can see that when Dividend Payout Ratio is 0 % market price per share is 120 as against only Rs. 102
when the Dividend Payout Ratio is 30 % .
THREE STAGES OF DIVIDEND DISCOUNT MODEL
QUESTION NO.31AThe current EPS of M/s VEE Ltd. is ` 4. The company has shown an extraordinary growth of
40% in its earnings in the last few year.This high growth rate is likely to continue for the next 5 years after which
growth rate in earnings will decline from 40% to 10% during the next 5 years and remain stable at 10% thereafter.
The decline in the growth rate during the five year transition period will be equal and linear. Currently, the
company’s pay-out ratio is 10%. It is likely to remain the same for the next five years and from the beginning of
the sixth year till the end of the 10th year, the pay-out will linearly increase and stabilize at 50% at the end of the
10th year. The post tax cost of capital is 17% and the PV factors are given below:
Years 1 2 3 4 5 6 7 8 9 10
PVIF@17% 0.855 0.731 0.625 0.534 0.456 0.390 0.333 0.285 0.244 0.209
You are required to calculate the intrinsic value of the company’s stock based on expected dividend. If the
current market price of the stock is `125, suggest if it is advisable for the investor to invest in the company’s stock
or not.
Solution:
Working Notes: (i)Computation of Growth Rate in Earning and EPS
Year 1 2 3 4 5 6 7 8 9 10
Growth in Earning 40% 40% 40% 40% 40% 34%* 28% 22% 16% 10%
EPS (`) 5.60 7.84 10.98 15.37 21.51 28.82 36.89 45.00 52.20 57.42
(ii)Computation of Payout Ratio and Dividend
Year 1 2 3 4 5 6 7 8 9 10
PayoutRatio 10% 10% 10% 10% 10% 18% 26% 34% 42% 50%
Dividend (`) 0.56 0.78 1.10 1.54 2.15 5.19 9.59 15.30 21.92 28.71
(iii)Calculation of PV of Dividend
Year Dividend (`) PVF PV of Dividend (`)
1 0.56 0.855 0.48
2 0.78 0.731 0.57
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3 1.10 0.625 0.69

4 1.54 0.534 0.82
5 2.15 0.456 0.98
6 5.19 0.390 2.02
7 9.59 0.333 3.19
8 15.30 0.285 4.36
9 21.92 0.244 5.35
10 28.71 0.209 6.00
24.46
28.71(1.1)
TV  x 0.209 = ` 94.29; Intrinsic Value = ` 24.46 + ` 94.29 = ` 118.75 5
0.17 0.10
Since the Intrinsic Value of Equity share is less than current market price, it is not advisable to invest in the same.
QUESTION NO.31B An investor is considering to purchase the equity shares of LX Ltd., whose current market
price (CMP) is ` 112. The company is proposing a dividend of ` 4 for the next year. LX Ltd. is expected to grow @
20 per cent per annum for the next four years. The growth will decline linearly to 16 per cent per annum after first
four years. Thereafter, it will stabilise at 16 per cent per annum infinitely. The investor requires a return of 20 per
cent per annum. You are required
(i)To calculate the intrinsic value of the share of LX Ltd. (ii)Whether it is worth to purchase the share at this price.
Period 1 2 3 4 5 6 7
PVIF (20%, n) 0.833 0.694 0.579 0.482 0.402 0.335 0.279
Solution:
D1 = ` 4; D2 = ` 4 (1.20) = ` 4.80; D3 = ` 4 (1.20)2 = ` 5.76; D4 = ` 4 (1.20)3 = ` 6.91; D5 = ` 6.91 (1.19) = ` 8.22
D6 = ` 6.91 (1.19) (1.18) = ` 9.70; D7 = ` 6.91 (1.19) (1.18) (1.17) = ` 11.35
D8 = ` 6.91 (1.19) (1.18) (1.17) (1.16) = ` 13.17
D1 D2 D3 D4 D5 D6 D7 1  D8 
P= + 2 +
3
+
4
+
5
+
6
+ + [ Ke - g  ]
(1  k e ) (1  k )
e (1  k e ) (1  k e ) (1  k e ) (1 + k e ) (1  k e )7 (1 + k e )7  
4.00 4.80 5.76 6.91 8.22 9.70 11.35 1

P= + + + + + + +
(1  0.20) (1  0.20)2 (1  0.20)3 (1  0.20)4 (1  0.20)5 (1  0.20)6 (1  0.20)7 (1 + 0.20)7
13.17
[ ] = 4.00 x 0.833 + 4.80 x 0.694 + 5.76 x 0.579 + 6.91 x 0.482 + 8.22 x 0.402 + 9.70 x 0.335 + 11.35 x
0.20  0.16
0.279 + 329.25 x 0.279
(i)Intrinsic Value = ` 114.91
(ii)As Intrinsic Value of the share is higher than its selling price of ` 112, it is under- priced and can be acquired.
However, other factors need to be taken into consideration since difference is only slightly higher.
CALCULATION OF DIVIDEND IN CASE OF VARIABLE GROWTH RATE MODEL
QUESTION NO.32 NM Ltd. (NML) is aspiring to enter the capital market in a three years’ time. The Board wants
to attain the target price of ` 70 for its shares at the end of three years. The present value of its shares is ` 52.03.
The dividend is expected to grow at a rate of 15% for the next three years. NML uses dividend growth model for
its projections. The required rate of return is 15%.
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You are required to calculate the amount of dividend to be declared by the board in the base year so as to
achieve the target price.
Period (t) 1 2 3
PVIF (15%, t) 0.8696 0.7561 0.6575
Solution:
Present value of Share = PV of Stream of Dividend upto 3 years + PV of Target price of share after 3 years
` 52.03 = PV of Stream of Dividend upto 3 years + 70.00 x 0.6575
PV of Stream of Dividend upto 3 years = ` 52.03 – ` 46.03 = ` 6
Let Base Dividend is D0, then
` 6 = D0 (1 + g) x PVIF (15%,1) + D0 (1 + g)2PVIF(15%, 2) + D0 (1 + g)3 PVIF (15%, 3)
` 6 = D0 (1.15) x 0.8696 + D0 (1.15)2 x 0.7561 + D0 (1.15)3 x 0.6575 or ` 6 = D0 +D0 +D0 = 3D0 ; D0 = ` 2
Thus, Company should declare a dividend of ` 2 in base year.
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Lets Start Our Valuation Chapter

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OPTIMUM DIVIDEND AS PER GROWTH MODEL

30(1 - .40) 30(1 - .60)

30(1  .40) 30(1  .60)

30(1  .40) 30(1  .60)

Calculate the intrinsic value of the share.

QUESTION NO.2O The following information is given about Swarnsathi Ltd.

QUESTION NO.2V Removed

Note:We assumed Dividend to remain same under both the situation.

QUESTION NO.2Z Removed

APPLICATION OF FLOTATION COST

HOLDING PERIOD RETURN (HPR)

(iii) Expected Capital Gain: P1 - P0 = 59.77 - 53.75 = 6.02

1.92 2.304  2.44224  1

VARIABLE/UNEQUAL GROWTH RATE

1.68 1.88 2.07 2.28 2.46 1.

QUESTION NO.5E Removed

QUESTION NO.5F Removed

QUESTION NO.5H Consider the equity share of India Incorporated

3.00(1.25) 3.00(1.25)2 3.00(1.25)3 3.00(1.25)4 3.00(1.25)5

QUESTION NO.5J Shifted To Q.31A

QUESTION NO.5K Shifted To Q.31B

QUESTION NO.5L Shifted To Q.32

OVERVALUED & UNDERVALUED SHARES

No sound in this world can be louder than silence and

QUESTION NO.6C Following are the details of X Ltd. and Y Ltd.:

NEGATIVE GROWTH RATE

IRR TECHNIQUE & GROWTH MODEL

1.20 1.44 1.73 2.07 2.49 2.49 (1  .10) 1

BOOK VALUE PER SHARE (BVPS)/WALTER’S MODEL

INCREASE OR DECREASE IN MPS DUE TO INVESTMENT

HOME MADE DIVIDEND

CALCULATION OF GROWTH RATE

DPSLatest year  DPSBase year (1  g)n1 or 1.46 = 1(1  g)n1 or g = 10%

Tutorial Note: Why n = 7 ?

ASSET TURNOVER RATIO (ATR)

If you feel down, always remember that for as long as your

Dividend @ 16.67% 5.20_

The most determinative sentence which should alwayz be followed in life-

Tax @ 30% 61.5

DECISION WHEN INVESTOR IS ALREADY HOLDING SHARE

VALUE AS PER PE MULTIPLE APPROACH AND EARNING GROWTH MODEL

QUESTION NO.15A (Study Material) On the basis of this information :

An Airoplane Is Always Safe At Ground.But It's Not Made For That.

EPS(1  g) 2.25(1  .02)

QUESTION NO.15B (8 Marks)(Exam Question) Given the following information :

QUESTION NO.15C Following information is available for M/s. ABC Ltd.

Since, Actual Stock Price is higher, hence it is overvalued.

(a)What is the expected price of the stock at the end of 2008?

above.Calculate rupee amount up to two decimal points.

30.52 33.27 36.26 720

Expected DPS at the end of fourth year = (9.60) (0.60) = `5.76

10(1 + 0.04)4 (0.55)

D4 1.25 x (1.08)4 1.25 x 1.3605

CALCULATION OF NPV DUE TO INVESTMENT