Learning Platforms- CAP II Financial Management Revision(Dec24)
Valuation of Securities
1. Basics
Investor point of view
Investment decision- Hold, Buy or sell
Overvalued or under-valued of stock by calculating intrinsic value.
Types of Securities
Fixed Income Securities Variable income securities
1. Debenture/Bond 1. Equity Share
2. Preference Share
2. Valuation of Securities
Bond/Debenture
Long term debt instrument that provides periodic return (i.e. interest) to investors and
have a certain maturity value.
Value of Bond (Bo) = Present Value of Future Cash Flow
Bond with a maturity period (Redeemable Bond)/ Plain Vanilla Bond
A bond or debenture issued for a specified period.
Using the present value concept, by discounting value of cash flow with required rate
of return i.e. annual interest payments plus its terminal / redemption / Maturity value,
its present value is calculated.
What if interest payments are semiannual?
Perpetual Bonds
Bonds or Debentures issued for indefinite periods are known as perpetual bonds.
They provide interest return for indefinite periods.
Mandira Khadka, CA
Learning Platforms- CAP II Financial Management Revision(Dec24)
In case of the perpetual Bonds, there is no maturity or terminal value.
The value of the bonds would simply be discounted value of the infinite stream of
interest flows.
Zero Coupon Bond
As name indicates these bonds do not pay interest during the life of the bonds.
When a zero-coupon bond matures, the investor receives one lump sum (at face
value).
Value of Bond is simply the present value of maturity value discounted with required
rate of return.
Maturity Value
Value of Bonds= n
(1+ Kd)
Convertible Debentures
Convertible Debentures are those debentures which are converted in equity shares
after certain period.
The equity shares for each convertible debenture are called Conversion Ratio and
price paid for the equity share is called ‘Conversion Price’.
Further, conversion value of debenture is equal to Price per Equity Share x Converted
No. of Shares per Debenture.
Preferred Stock/Preference Share
Preference shareholders have preference right over payment of dividend and settlement
of principal amount upon liquidation, over common shareholders.
Redeemable preference shares
Redeemable preference shares have a fixed maturity date.
Irredeemable preference shares
Irredeemable preference shares have perpetual life with only dividend payments
periodically upon profit availability.
Basically, the value of preference share is the present value of all the future expected
dividend payments and the maturity value, discounted with required return on
preference shares.
Mandira Khadka, CA
Learning Platforms- CAP II Financial Management Revision(Dec24)
Common Stock or Equity Shares
Equity shares are long-term financing sources for any company.
These shares are issued to the general public and are non-redeemable in nature.
The value of a share of stock should be equal to the present value of all the future cash
flows that an investor expects to receive from that share.
Since common stock never matures, today's value is the present value of an infinite
stream of cash flows.
Dividend Valuation Model
Cash inflows expected from an equity share will consist of dividends expected to be
received by the owner while holding the share and the price which he expects to
obtain when the share is sold.
Single period valuation
If an investor can thus, represent his expectation with regard to future share price in
terms of expected growth. If the share price is expected to grow at g percent, then we
can write (P1) as follows:
Multi – Period Valuation
Valuation based on Multi Holding
Period
Zero
Growth Constant Growth Variable growth
Mandira Khadka, CA
Learning Platforms- CAP II Financial Management Revision(Dec24)
o Zero Growth
It is also called as constant dividend, as dividend amount remains same over the
infinite period. The value of equity can be found as follows:
o Constant Growth
According to constant growth, it is assumed that the growth of dividend is
constant over infinite period.
The value of equity shared can be found by using following formula:
o Variable Growth Rate
Accordingly, valuation of equity shares can be done based on variable growth in
dividends. Multiple growth rate is used to calculate the price of equity.
Mandira Khadka, CA
