Business Analysis and V l tiValuationIntroductiontoValuationIntroductiontoValuation

Prof.PitabasMohantyProf.PitabasMohanty

ContentContent

M d l 1 Th f DCF V l ti (5 S i ) Module1:TheoryofDCFValuation(5Sessions) Module2:PracticeofDCFValuation(56Sessions) Module3:RelatedIssues(4Sessions)

M&AValuation PrivateCompanyValuation VentureCapitalValuation

Module4:NonDCFValuation(3Sessions) MultiplierMethods RealOptionsMethod

ClassTestsin2sessions Session5or6(Quiz1) Session12or13(Quiz2)

About the Course

Pedagogy Lectures(Dobringyourscientificcalculatortoall theclasses)( g y ) CaseDiscussions(4Cases) Project(GroupProject)

Howtoselectthe2companies

GroupProject Groupsizeof5.Eachgrouptovalue2companiesfromthesamesector.AtleastoneIndiancompany.S b i i t b d ithi k ft M d l 2 i Th ill SubmissiontobemadewithinaweekafterModule2isover.Thegroupwilllooseonegradepointforeveryweeksdelayedsubmission.

Yourgroupmaybeaskedtomakeasurprisepresentationoftheinterimprogressreportintheclass.Randomlyselectedmembersofthegroupmaybeinterviewedtoknowtheprogressmadeintheproject.

CourseMaterial Photocopiesofmybook(tobepublished) ClassSlides(Canbedownloadedfrommywebsite)

Evaluation (Relative Grading)Evaluation (Relative Grading)

E l ti Evaluation TwoClassTests:30%

Firsttestaftermodule1 Secondtestaftermodule2

Project:25% ClassAttendance:10%

5marksforclassattendance(@1markforeveryclassattendedforwhichattendance is taken)attendanceistaken)

Endterm:35% Additionalassignment(shortpaperfortheFPMstudents):25%

Meetmeinmyofficeseparatelyfordetails.

Code of ConductCode of Conduct

N ll h t b d Nocellphonetobeused. Ifyouarefoundusingaphone,phonewillbeconfiscated.

Nocopyinginquizzes,examsandproject.ll f b i l f d h d f h (i Allreferencesmustbeappropriatelyreferencedattheendofthepage(ina

footnote). Ifyouhavecopiedandpastedapicturefromawebsite,thesourceofthewebsite(anddateaccessed)mustbeputnexttothepicture.

Norequestforpostponementof Quizzes Submissionofdeadlines

Ifyourequestforextensionofdeadlineorpostponementofquizzes,youwillgetFinthatparticularcomponent.

To Understand Company Valuation You p yMust be an Expert in

C t Fi CorporateFinance TimeValueofMoney RiskandReturn Stock and Bond Valuation StockandBondValuation CapitalStructureTheory

FinancialAccountingI d t i l E i IndustrialEconomics

Statistics(RegressionAnalysis)

Answer these questionsAnswer these questions

A ti l i k i i d Wh t d it ? Aparticularriskispriced.Whatdoesitmean? Separationtheoremholds.WhatdoesitmeaninthecontextofMM? Differencebetweenagoodcompanyandagoodstock Astockisexpectedtogive50%return.Therequiredrateofreturnis20%.Whatisthedifference?

D0 = Rs.5. D1 = Rs.7. The expected growth rate in dividend is 6%. TheD0 Rs.5.D1 Rs.7.Theexpectedgrowthrateindividendis6%.Therequiredrateofreturnis12%.Whatisthecumdividendstockprice?

Thegrowthrateinthedividenddiscountingmodelreferstothegrowth rate in i) sales, ii) profit, iii) dividend.growthrateini)sales,ii)profit,iii)dividend.

YouarevaluingAirtel.CanyouusePEratioofSingtel asabenchmark?

What happens to the cost of capital as the debt ratio increases? Whathappenstothecostofcapitalasthedebtratioincreases?

Different Valuation MethodsDifferent Valuation Methods

Di t d C h Fl M th d DiscountedCashFlowMethod FCF,CCF,FCFE,APV,EVA,DDM,etc.allfallinthiscategories

RelativeValuationMethodl k l i li h d AlsoknownasMultiplierMethod

RealOptionsValuationMethod CostMethod

Where does FCF Method give us gUnsatisfactory Answer?

Wh FCF ti WhereFCFsarenegative. Whenafirmhaslotsofunutilized(underutilized)assets Whenafirmhasrealoptions Thereisnoguaranteethatanythingwillemergeasunder orovervalued.Itispossiblethatyoufindallthestockstobeovervaluedatapoint.Thiscanbeaproblemtothefundmanagersandanalystswhoaretrackingstocksfromasector.

Relative Valuation MethodRelative Valuation Method

H l t b l ki t th l f bl Here,wevalueanyassetbylookingatthevaluesofcomparableassets(lookingatpricesrelativetoearnings,cashflows,bookvalue,etc.)

A typical relative valuation model would work as follows: Atypicalrelativevaluationmodelwouldworkasfollows: Forecastanaccountingnumber(X)andfindhowmuchvaluethemarketiswillingtoputperunitofX.GettheValuetoXratio.

Examples:p PriceEarningsRatio PricetobookRatio PricetosalesRatio(Whatdoyouthinkthisratiomeasures?)

ExamplesExamples

Sales Earnings BookValue MarketValue P/S P/E P/B

HP $84,229 $7,264 $38,526 $115,700 1.37 15.9 3.0

Lenovo 14,590 161 1,134 6,381 0.44 39.6 5.6

Dell 61 133 2947 3 735 ? ? ? ?Dell 61,133 2947 3,735 ? ? ? ?

$ Figures in Millions Market Value figures are as of end August 2008$FiguresinMillions.MarketValuefiguresareasofendAugust,2008.

Real Options MethodReal Options Method

Y h b illi t t h i l id Y t t k if th id Youhaveabrillianttechnicalidea.Youwanttoknowiftheideamakescommercialsense.

YouapproachaVCforaRs.10millioninvestment.Thereisa90%chance this venture will not succeed There is a 10% chance it willchancethisventurewillnotsucceed.Thereisa10%chanceitwill.

Iftheideaturnsouttobecommerciallyviable,thentheVChasthesolerighttomaketherequiredadditionalinvestmentsnextyear(around Rs 100 million) The NPV of this investment will be Rs 400(aroundRs.100million).TheNPVofthisinvestmentwillbeRs.400million.

Whatisthevalueofyourinvestment?

Real Options Valuation ModelReal Options Valuation Model

I i l i th h f TV h l th t j t ImagineyouarevaluingthesharesofanewTVchannelthatjustboughtthesoleviewingrightsinIndiaforthenextmovieofHimeshReshammiya for2years.

Or you are valuing a new pharmaceutical company that has invested Or,youarevaluinganewpharmaceuticalcompanythathasinvestedRs.50millioninanewdrug.Itisinadvancedstageoftheresearchprocess.Yettogetpatent.Ifitgetsthepatent,itsvaluewillbeRs.50crores. If it does not, it probably will file for bankruptcy.crores.Ifitdoesnot,itprobablywillfileforbankruptcy.

R f DDM d MMRecap of DDM and MM BusinessAnalysisandValuation(BAV)

Dividend Discounting ModelDividend Discounting Model

Wediscountactual(potential)dividendatrtoobtainthestockprice. Assumptionnormallymadeaboutr:

Investor is diversifiedInvestorisdiversified rremainsconstantovertime Neitherassumptionisneeded.Buttheysimplifythecalculations. risnormallycomputedusingCAPMequation. ristherequiredrateofreturn andnottheexpectedrateofreturn.Inanefficientmarket,onecan,ofcourse,usethesetwotermsinterchangeably.

Example:ExpectedP1(exdividend)=$105.ExpectedD1=$5.Youneedaminimumreturnof10%fromthestockbasedonitsrisk.Thisistherequiredrateofreturn.Sothemaximum price you should be willing to pay for the stock today is $100 Suppose themaximumpriceyoushouldbewillingtopayforthestocktodayis$100.Suppose,thestockisundervaluedandtradesat$90.Thenyourexpectedreturnis20/90=22.22%.

Constant DividendConstant Dividend

Constant Growth in DividendConstant Growth in Dividend

An Example

Example contdExample, contd.

If th t d th t i 0 th th t ti ill b 100% Iftheexpectedgrowthrateis0,thenthepayoutratiowillbe100%.Theexpecteddividendpersharewillbe$10.Thepricewillbegivenby:P0=10/0.2=$50pershare.

Since the ROE and the required rate of return r are equal growth SincetheROEandtherequiredrateofreturnrareequal,growthwillhavenoeffectonthestockprice.

BookValuepershareisdefinedasNetWorthdividedbythenumberof sharesofshares.

Forthiscompany,thebookvalueisgivenby:$100million/2million=$50pershare.Sincethepriceisalsoequalto$50pershare,theprice to book ratio is 1pricetobookratiois1.

Infact,whenevertheROEandrareequal,thePBVratiowillequal1.Thatiswhy,1issometimesusedasthebenchmarkPBVratio.

What if the Payout Ratio and ROE change over time?g

Year0 Year1 Year2

Net Worth (yearend) NW0 (1) NW0 + PAT1(1b1)(5)

Return on Equity* ROE1 (2) ROE2 (6)

Net Income PAT1 =(NW0 ROE1) (3)

PAT2= [NW0+PAT1(1b1)]ROE2 (7)

Payout Ratio b1 (4) b2 (8)

)1( ROENWROEbPATNW

)5(2...)()1(

)1(

1

1212

10

102110

aROE

ROEROEbROE

ROENWROENWROEbPATNWg

Multi stage Growth ModelMulti-stage Growth Model

Infosys paid dividend of Rs 63 per share for the year ending 31 March InfosyspaiddividendofRs.63persharefortheyearending31March,2014.Analystsexpectthelongtermprofitgrowthratetobe14.19%forInfosys(Source:http://in.reuters.com/finance/stocks/analyst?symbol=INFY.NS).Theprojectedgrowthratesfor2015and2016are11.14%and13.82%,respectively.

Therequiredrateofreturnis13.63%.Letsassumetheterminalgrowthrateto be 6%tobe6%.

WhatistheintrinsicvaluepershareofInfosys?IttradesaroundRs.3,160. Canweusetheprofitgrowthrateasaproxyforthedividendgrowthrate?

Th i NO if th fit th t h f t TheanswerisNO,iftheprofitgrowthratechangesfromyeartoyear. ThetrickistofindtheimpliedretentionratiobydividingtheprojectedROEwiththegrowthrate.Thencomputethepayoutratioandfinallyprojectthedividend.dividend.

Intrinsic Value per shareIntrinsic Value per share

2014 2015 2016 2017 2018 2019 2020DPS 63 70.0196 79.69573 91.00455 103.9181 118.6641 125.7839g 11.14% 13.82% 14.19% 14.19% 14.19% 6.00%Price 1 180 83 1648 89Price 1,180.83 1648.89

2014 2015 2016 2017 2018 2019 2020DPS 63 70.0196 79.69573 91.00455 103.9181 118.6641 125.7839g 11.14% 13.82% 14.19% 14.19% 14.19% 6.00%Price 1,180.83 1648.89ROE 25.83% 25.83% 25.83% 25.83% 25.83% 25.83% 25.83%EPS 186.49 207.2691 235.912 269.3879 307.6141 351.2645 372.3404P R i 0 3378197 56 86% 46 50% 45 06% 45 06% 45 06% 76 77%PayoutRatio 0.3378197 56.86% 46.50% 45.06% 45.06% 45.06% 76.77%DPSAdjusted 63 117.86 109.70 121.40 138.62 158.29 285.85CorrectIntrinsicValue 2,416.35 3,747.18

Net Present Value of Growth Opportunities (NPVGO)

Example of NPVGO ThenetworthofZLimitedason31.3.2015isRs.100million.TheROEis20%.Therefore,theprofitaftertaxfortheyearended31.3.2016isRs.20million.Therequiredrateofreturnis16%.Thereare4millionshares outstandingsharesoutstanding.

ThevalueofthestockisRs.31.25intheabsenceofgrowth. ThevalueincreasestoRs.34.09iftheprojectedgrowthrateis5%. SotheVGOisgivenby:

VGO=Rs.34.09 Rs.31.25=Rs.2.84 ThisisactuallyequaltothepresentvalueoftheNPVsofthenewprojectsthecompanyisgoingtoinvestintoachieve5%growth.co pa y s go g to est to ac e e 5% g o t .

NPVGO and Price Earnings RatioNPVGO and Price-Earnings Ratio

Understanding Modigliani and Miller (MM)

Some TerminologySome Terminology

V l t i l ? Valueorenterprisevalue? Businessriskandfinancingrisk Unleveredcostofequity(unleveredbeta) Leveredcostofequity(leveredbeta)

MM without TaxMM without Tax

MM in the presence of Tax