VALUATION
Agenda
Marks Structure
Session Plan
Introduction to Valuation
MARKS STRUCTURE
Marks Structure
100 marks
40 marks
60 marks Final Internals
Paper
Group Project
Group Project Details
Group project with each individual choosing a
company
All companies within the group should be from the
same sector or theme
INTRODUCTION
What is Value Creation?
Companies that grown an earn a return on capital that
exceeds their cost of capital create value
- Alfred Marshall
Refer to Case
Introduction
❑ Valuation is not a science but a skill to be honed
❑ Valuation is a personal judgement around the value of an
asset
❑ Objective of this class is to learn the techniques and the apply
judgment
Personal judgement
and interpretation
to derive value
Building
Blocks or
Techniques
Introduction
Valuation is thought to be done on publicly listed companies
Every asset has value and different valuation techniques can
be used to find its value
Value of an asset changes based on perspective; internal vs
external, activist vs retail investor and so on…
Valuing an asset requires hard numbers and story telling
Valuation is also subject to bias
Difference between Value and Price
Value of an asset may be very different from its price
In 1949, Benjamin Graham coined the term Mr. Market to explain extreme
fluctuations in the price of securities. Mr. Market is described as a partner in
the reader’s business who offers to buy out or sell additional interest in the
business at his perception of price, which fluctuate wildly
Mr. Market has the following characteristics
Is emotional, euphoric, moody
Is often irrational
Offers that transactions are strictly at your option
Is there to serve you, not to guide you
Is in the short run a voting machine, in the long run a weighing machine
Will offer you a chance to buy low, and sell high
Is frequently efficient…but not always
Difference between Value and Price
Difference between Value and Price
Value of an asset may be very different from its
price
Valuation Pricing
Value is based on cash flows, Price of an asset is based on
growth and risk demand and supply
Value is derived by researching Price is derived by looking at
on the business model of a similar assets being priced in
company and its value drivers the market
There are no bounds to pricing
Difference between Value and Price
Difference between Value and Price
When would value and price of a security be the same?
What has to be true about markets for value and price
to converge?
Acting on your valuation when there is a divergence
between value an price
Prevalence of Pricing over Valuation in Finance
Why do Valuation?
Why do Valuation?
Articles delivered in exchange of one rare tulip bulb called the
Viceroy
Why do Valuation?
Valuation reduces chances of losses which occur while going with
the crowd and increases the margin of safety
Myths around Valuation
Valuation is an objective exercise to estimate ‘true’
value. If a valuation estimate is already given to
you, your own assessment will anchor towards that
estimate
Valuation is a precise estimate of value
A complex model is a sign of precision
Assumptions of using Valuation
Markets are inefficient but will eventually correct
itself to find efficiency
Valuation is an approach to find these inefficiencies
Tools for Valuation
Intrinsic Valuation or Discounted Cash Flow
Approach
Relative Valuation or Pricing
Option based Valuation
TIME VALUE OF
MONEY
What is Time Value of Money?
A rupee is worth more today than it is worth in the
future
Money earned in the future should be discounted to
arrive at its present value
Money earned today can be compounded to earn
a larger sum in the future
Future Value Formula
Present Value Formula
Examples of Time Value
A manager wants to replace an existing asset 10
years later at a cost of Rs. 10,000. How much should
the company save and invest today assuming the
investments earn a return of 8%
Examples of Time Value
A manager wants to replace an existing asset 10
years later at a cost of Rs. 10,000. How much should
the company save and invest today assuming the
investments earn a return of 8%
PV = 46319.35
Examples of Time Value
We want to find the present value of $20,000 paid
12 years from now using a discount rate of 10%
compounded quarterly
Examples of Time Value
We want to find the present value of $20,000 paid
12 years from now using a discount rate of 10%
compounded quarterly
PV = 6113.42
Examples of Time Value
Calculate the present value of the following cash flows
with a 10% discount rate
Cash Flows
15,000
20,000
15,000
20,000
25,000
Examples of Time Value
Cash Flows DF @ 10% Disc. Cash Flows
15,000 0.909 13,636.36
20,000 0.826 16,528.93
15,000 0.751 11,269.72
20,000 0.683 13,660.27
25,000 0.621 15,523.03
TOTAL 70,618.31
Examples of Time Value
Calculate the present value of the following cash flows
with a 12% discount rate
Cash Flows
25,000
30,000
25,000
30,000
35,000
Examples of Time Value
Cash Flows DF @ 12% Disc Cash Flows
25,000 0.89 22,321.43
30,000 0.80 23,915.82
25,000 0.71 17,794.51
30,000 0.64 19,065.54
35,000 0.57 19,859.94
1,02,957.23
Examples of Time Value
A company’s current sales are Rs. 100 million. If
sales grow at 8% a year, how large will they get at
the end of 10 years?
Examples of Time Value
FV = PV (1 + r)N
FV = 100 (1 + 0.08)10
FV = 215.89
Examples of Time Value
Suppose a government bond will pay Rs. 1,000
three years from now. If the going interest rate on 3
years government bond rate is 4%, how much is the
bond worth today?
Examples of Time Value
PV = FV / (1 + r)N
PV = 1000 / (1 + 0.04)3
PV = 889
Examples of Time Value
A government bond is selling at Rs. 613.81. No
payments will be made until the bond matures 10
years from now, at which time it will be redeemed
for Rs. 1,000. What interest rate would you earn if
you bought the bond at offer price?
Examples of Time Value
PV = FV / (1 + r)N
613.81 = 1000 / (1 + r)10
r = 5%
Examples of Time Value
ABC Corp's 2005 earnings per share were Rs.
2, and its growth rate during the prior 5 years was
11.0% per year. If that growth rate were
maintained, how long would it take for Addico’s EPS
to double?
Examples of Time Value
PV = FV / (1 + r)N
2 = 4 / (1 + 0.11)N
6.6 years
Discounted Cash Flow Approach
It is the a present value of discounted cash flows of
an asset
Discounted Cash Flow Approach
An intrinsic value exists for each asset based on
cash flows, growth and risk
You will need an estimate of the life of an asset,
cash flows and discount rate
Advantages of DCF
It is an assessment of how fundamentals of a business
affect value. It looks at stocks in terms of businesses
Does not rely on the market’s assessment of value
Assumptions around fundamentals can be updated as
more information is available
Suited for long term investments
Disadvantages/ Limitations of DCF
Cumbersome approach as each input needs to be estimated and
business model need to be analysed
The inputs can be changed to arrive at a pre-conceived answer of
the value of a company
It may be difficult to implement DCF valuation results across a
portfolio as results may be one sided for an entire sector/s
Cannot be used for non cash flow generating assets
Difficult to commit psychologically as most buy/ sell decisions tend to
be contrarian
Relative Valuation/ Pricing Approach
Value/ price is calculated by looking at similar asset
prices in the market
Standardised Price = Price of Asset A / Value Driver
Parameters for estimating price need to be selected
correctly
Differences between similar assets need to be
accounted for
Advantages of Relative Valuation/ Pricing
Trusting the market for under and over valuation
Suitable for shorter term strategies and trading
Less cumbersome to calculate
More suitable for fund managers as they are judged by
relative valuation
Suitable when similar assets with comparable parameters
exist, example, real estate
Suitable for long/ short fund rather than long only funds
Disadvantages of Relative Valuation/ Pricing
The market or sector as a whole may be over
valued
May not be the best method for judging value of
individual securities on an absolute basis
Types of Assets
Pricing Valuation
Equity Equity
Commodity Commodity
Currency
Collectible
Asset based Valuation
Valuing individual assets rather than the entire
business
Option based valuation
What is an option?
We can use option based valuation for assets with
similar characteristics to options
A firm on the verge of bankruptcy
A firm owning exclusive rights to a product
A firm owning a natural resource reserve
