Equity & Business Valuation

Equity & Corporate Valuation
A. Dividend based Valuation Models

QUESTION 1:
N 10 | N 08
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:
As per CAPM:
ER = Rf +  (Rm – Rf)
= 10 + [1.2 (15 – 10)]
= 16% or 0.16
Applying dividend growth mode for the calculation of equilibrium price:-
D1
P0 =
Ke  g
3(1.12)
=
0.16 - 0.12
= ₹84
Therefore, equilibrium price per share will be ₹ 84.
QUESTION 2:
N 20 | N 11 | SM
A company has a book value per share of ₹ 137.80. Its return on equity is 15% and it follows a policy
of retaining 60% of its earnings. If the Opportunity Cost of Capital is 18%, what is the price of the
share today?
Solution:
EPS = 137.80  15% = 20.67
DPS = 20.67  (1-0.60) = 8.268
g = 0.15  0.060 = 9%
D1
Price of share (P0) =
Ke  g
= 8 . 268 = 91.87
0 . 18  0 . 09
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Adish Jain CA CFA
QUESTION 3:
SM | M 21 | M 05
A company’s beta is 1.40. The market return is 14%. The risk free rate is 10% (i) What is the expected
return based on CAPM (ii) If the risk premium on the market goes up by 2.5% points, what would be
the revised expected return on this stock?
Solution:
Expected Return = Rf +  (Rm + Rf)
= 10 + 1.40 (14 – 10)
= 15.6%
Revised risk premium = (14% - 10%) + 2.5%
= 6.5%
Revised expected return = 10 + 1.40 (6.5)
= 19.1%
QUESTION 4:
N 21
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%
a. Calculate the price of shares of both the companies.
b. Write the comment on the valuation on the basis of price calculated and current market price.
c. As an investor what course of action should be followed?
Solution:
a) 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%] = 7% + 1.20 [14% - 7%]
= 13.30% = 15.40%
Growth Rate 10% 10%
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Price of Share 4.00 4.00

= =
0.133 - 0.10 0.154 - 0.10
= ₹ 121.21 = ₹ 74.07
b) and c) Comment on valuation and course of action:

company CMP Value Valuation Action of the Investor
X Ltd. ₹ 150.00 ₹ 121.21 Overvalued Not to Invest/ to be sold
Y Ltd. ₹ 70.00 ₹ 74.07 Undervalued Invest/ to be purchased
QUESTION 5:
M 15
The following information is collected from the annual reports of J Ltd:
Profit before tax ₹ 2.50 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 according to Gordon’s model of dividend policy?
Solution:
PBT 2,50,00,000
Less: Tax @ 40% (1,00,00,000)
EAES 1,50,00,000
÷ No. of shares 50,00,000
EPS 3
Calculation of DPS = 3  0.60 = 1.80

Calculation of growth = 0.40  0.15 = 6%
D1
Price of share (P0) =
Ke  g
= 1 . 80
 30
0 . 12  0 . 06
QUESTION 6:
N 18 | N 13 | M 11 | M 05 | SM | RTP
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Adish Jain CA CFA
Shares of Voyage Ltd. are being quoted at a price-earnings ratio of 8 times. The company retains ₹ 5
per share which is 50% of its Earning Per Share.
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:
1. Retained Earnings ₹ 5 per share
Retention ratio 50%
EPS ₹ 10
DPS ₹5
PF Ratio 8 times
Market Price ₹ 10  8 times = ₹ 80
D
Computation of cost of equity = 1 +g
P0
= 5 + 0.15
80
= 21.25%
D1 5
2. Market Price = 
ke  g 0.2125 0.16
= ₹ 95.24
D1 5
3. Market Price = 
ke  g 0.20  0.18
= ₹ 250
QUESTION 7:
MTP N 23 | M 18 | N 14
The risk-free rate of return Rf is 9 percent. The expected rate of return on the market portfolio Rm is
13 percent. The expected rate of growth for the dividend of Platinum Ltd. is 7 percent. The last
dividend paid on the equity stock of firm A was ₹ 2.00. The beta of Platinum Ltd. equity stock is 1.2.
a. What is the equilibrium price of the equity stock of Platinum Ltd.?
b. How would the equilibrium price change when:
 The inflation premium increases by 2 percent?
 The expected growth rate increases by 3 percent?
 The beta of Platinum Ltd. equity rises to 1.3?
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Adish Jain CA CFA
Solution:
a. Calculation of cost of equity by using CAPM
= Rf +  (Rm – Rf)
= 9 + 1.2 (13 - 9)
= 13.8%
Calculation of equilibrium price
D1
=
Ke  g
= 2 1  0 . 07 
0 . 138  0 . 07
= ₹ 31.47
b. Revised price after the change:
Rf = 11%
Rm = 15%
Growth = 10%
Beta = 1.3
Calculation of Ke by using CAPM
= Rf +  (Rm + Rf)
= 11 + 1.3 (15 – 11)
= 16.2%
Equilibrium price after the change:
D1
=
Ke  g
2 (1 + 0.1)
=
0.162 - 0.10
= 35.48
QUESTION 8:
M 13 | SM | RTP
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
a. The maximum amount Mr. B should pay for shares, if he requires a rate of return of 13% per
annum.
b. The maximum price Mr. B will be willing to pay for share, if he is off the opinion that the 9%
growth can be maintained indefinitely and require 13% rate of return per annum.
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Adish Jain CA CFA
c. 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.
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:
a) Calculation of Dividends
Year 0 1 2 3 4
Growth 9% 9% 9% 9%
Dividend 14 15.26 16.63 18.13 19.76
The maximum amount Mr. B should pay for share
Year CF’s PVAF@13% PV
1 15.26 0.885 13.5051
2 16.63 0.783 13.0213
3 18.13 + 360 0.693 262.044
Max Amount 288.57
b. Gordon’s formula
If growth rate 9% is achieved for indefinite period, then maximum price of share should Mr. A
willing be to pay is
D1
=
Ke  g
= 15 . 26
0 . 13  0 . 09
= ₹ 381.5
c. Max price paid of the end of 3 year
P3 = D4
ke  g
19 . 7621

0 . 13  0 . 09
= ₹ 494.05
QUESTION 9:
M 21
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 ₹
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Adish Jain CA CFA
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%.
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:
value of Share = PV of Dividend for 3 years + PV of Target price after 3 years
₹ 52.03 = PV of Dividend for 3 years + 70.00  0.6575
PV of Dividend for 3 years = ₹ 52.03 - ₹ 46.03 = ₹ 6
Let Base Dividend is D0, then
6 = D0 (1+g)  PVIF (15%,1) + D0 (1+g)2  PVIF (15%, 2) + D0 (1+g)3  PVIF (15%, 3)
6 = D0 (1.15)  0.8696 + D0 (1.15)2  0.7561 + D0 (1.15)3  0.6575
D0 = 2
Thus, Company should declare a dividend of ₹ 2 in base year.
QUESTION 10:
MTP M 15
SRK Ltd. is a listed company and it has just announced annual dividend for the year ending 2013-14.
Earnings Per Share (EPS) and Dividend Per Share (DPS) for 5 years is as follows:
₹ 2013-14 2012-13 2011-12 2010-11 2009-10
EPS 14 13.6 13.1 12.7 12.2
DPS 8.2 8.1 7.9 7.8 7.7
In the opinion of MD of SRK Ltd., if current dividend policy is maintained annual growth in Earnings
and Dividends will be no better than the annual growth in earnings over the past years
Since the Board of SRK Ltd. is reluctant to take debt to finance growth it is considering changing its
dividend policy by retaining 50% of its earnings for investment in various projects having a post-tax
rate of return of 15%. The beta of SRK Ltd. is 1.5, market risk premium is 4% and Risk Free Rate of
Return is 6%.
You are required to calculate expected market price of share, if
a. SRK Ltd. does not announce a change in its Dividend Policy.
b. SRK Ltd. does announce a change in its Dividend Policy by retaining 50% of its earnings.
Note: Growth Rate can be assumed to be remain stable.
Solution:
a) Calculation of cost of equity using CAPM
Ke = Rf +  (Rm – Rf)
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Adish Jain CA CFA
= 6 + 1.5 (4)
= 12%
14.00 1/4
Average Growth Rate = – 1 = 3.5%
12.20
Calculation of MP by Gordon’s formula
D1
P0 =
Ke  g
= 8 .2  1 .035
0 .12  0 .035
= 99.85
b) Dividend Payout Ratio: = 50%
RR = 1 – 0.5 = 50%
ROE = 15%
Calculation of growth rate
= RR  ROE
= 0.50  0.15
= 7.5%
D1 = 14  50%  1.075
= 7.525%
D1
P0 =
Ke  g
= 7 .525
0 .12  0 .075
= 167.22
QUESTION 11:
M 12 | RTP N 18
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.
a. 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?
b. 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:
3.36
(a) 146 =
k e  0.075
Ke = 9.80 %
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(b) Revised growth = RR  ROE

= 60%  0.10
= 6%
 Existing D1 = ₹ 3.36
 Existing RR
g = RR  ROE
7.5% = RR  0.10
RR = 75%
 Existing Payout Ratio = 1 – 0.75 = 25%
3.36
 Existing EPS1 = = ₹ 13.44
25%
13.44
 Revised EPS1 =  1.06 = 13.25
1.075
 Revised D1 = 13.25  (1 – 0.60)
= 5.3
D1
 Ke = +g
P0
5.3
= + 0.06 = 9.63%
146
QUESTION 12:
N 18
A Company has an EPS of ₹ 2.50 for the last year and 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:
a. An estimate of the P/E Ratio using Gordon Growth Model,
b. The Long-Term Growth Rate implied by the Current P/E Ratio.
Solution:
D1
(a) P0 =
Ke  g
1 1.02
=
0.14  0.02
= 8.5
MP 8.5
PE Ratio =   3.4 times
EPS 2.50
(b) PE Ratio (Current) = 7 times
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Adish Jain CA CFA
Price per share = ₹ 2.50 x 7 times

= ₹ 17.50
We know that
D1
P0 =
Ke  g
17.50 = ₹ 1(1+g)/ (0.14 – g)
g = 7.84%
QUESTION 13:
N 22 | M 21 | M 19 | N 12 | N 09 | RTP
Following Financial data are available for PQR Ltd. for the year 2008:
(₹ in lakh)
8% debentures 125
10% bonds (2007) 50
Equity shares (₹ 10 each) 100
Reserves and Surplus 300
Total Assets 600
Assets Turnovers ratio 1.1
Effective interest rate 8%
Effective tax rate 40%
Operating margin 10%
Dividend payout ratio 16.67%
Current market price of Share ₹ 14
Required rate of return of investors 15%
You are required to:
a. Draw income statement for the year
b. Calculate its sustainable growth rate of earnings
c. Calculate the fair price of the Company’s share using dividend discount model, and
d. What is your opinion on investment in the company’s share at current price?
Solution:
Turnover
(a) Assets T/O Ratio =
Total Assets
T /O
1.1 =
600
T/O = 660
Since, operation margin is 10%
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Therefore, Operating cost is 90%

Income statement
(₹ Lakhs)
Sales 660
Less: Operating cost (660  90%) (594)
EBIT 66
Less: Interest (125 + 50)  8% (14)
EBT 52
Less: Tax @ 40% (20.8)
EAT 31.2
Less: Dividend @ 16.67% (5.20)
Retained Earnings 26
EAES 31.2
(b) ROE =   7.8%
Eq. SHF 100  300
Sustainable growth rate = RR  ROE
= 0.8333  0.078
= 6.5%
(c) Using Gordon’s formula
5.2 Lakhs
D1 = = ₹ 0.52
10 lakhs
D1
P0 =
Ke  g
0.521.065
=  6.51
0.15  0.065
(d) Current MP = 14, the share is overvalued. Hence investor should not invest in the company.
QUESTION 14:
N 20
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 1 Proposal 2
Target Assets to Sales Ratio 0.65 0.62
Target Net Profit Margin (%) 4 5
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Target Debt Equity Ratio (DER) 2:3 4:1

Target Retention Ratio (of earnings) (%) 75 -
Annual Dividend (₹ In Lakhs) - 0.3
New Equity Raised (₹ In Lakhs) - 1
You are required to calculate sustainable growth rate for both the proposals.
Solution:
Sustainable growth rate for proposal I:
Total Sales = 30 Lakhs
Asset
Asset to sales Ratio =
Sales
Assets
0.65 =
30 Lakhs
Assets = 19.5 Lakhs
Net profit margin = 30 lakhs  4%
= 1.2 lakhs
Target Debt to Equity = 2:3
Total capital = Total assets = 19.5 Lakhs
3
Equity portion in total capital = 19.5 Lakhs 
2+3
= 11.7 Lakhs
PAT or EAES
Return on Equity (ROE) =
ESHF
1.2
= = 10.26%
11.7
Sustainable Growth Rate = RR  ROE
= 0.75  10.26%
= 7.695%
~ 7.70%
Sustainable growth rate for proposal II:
Total Equity = ₹ 12,00,000 + 1,00,000
= 13,00,000
Debt
Debt equity Ratio =
Equity
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Adish Jain CA CFA
Debt
4 =
13,00,000
Debt = 52,00,000
Total capital = 13,00,000 + 52,00,000
= 65,00,000
Total Assets = 65,00,000
Asset
Assets to Sales =
sales
65,00,000
0.62 =
Sales
Sales = 104.84 lakhs
Net profit = 104.84 lakhs  5%
= 5.242 lakhs
PAT or EAES
Calculation of ROE =
ESHF
5.242
=
13,00,000
= 40.32%
0.3
Payout Ratio =
5.242
= 5.72%
Retention Ratio = 100% – 5.72%
= 94.28%
Sustainable growth rate = RR  ROE
= 94.28%  40.32%
= 38.01%
Self-note: Solution to this question will not match with institute’s solution as their solution has major
conceptual mistakes.
QUESTION 15:
N 04 | RTP
Mr. A is contemplating purchase of 1,000 equity shares of a Company. His expectation of return is
10% before tax by way of dividend with an annual growth of 5%. The company’s last dividend was ₹
2 per share. Even as he is contemplating, Mr. A suddenly finds, due to a Budget announcement
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Adish Jain CA CFA
Dividends have been exempted from Tax in the hands of the recipients. But the imposition of
Dividend Distribution 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%.
Required:
Calculate what should be Mr. A’s estimates of the price per share before and after the Budget
announcement?
Solution:
Post Tax Ke = Pre-Tax Ke  (1-t)
= 10%  (1 – 0.3)
= 7%
D0 (1 + g)
Value of a share based on expected dividend: P0 =
ke - g
2 × (1 + 0.05)
Price estimate before budget announcement: P0 = = Rs 42.00
(0.10 - 0.05)
1.80 × (1 + 0.05)
Price estimate after budget announcement: P0 = = Rs 94.50
(0.07 - 0.05)
QUESTION 16:
MTP M 16
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 at the end of the year, if
a. there is no growth in dividend?
b. dividend grows at constant rate of 5% per annum in perpetuity?
c. constant dividend for first five years and then grows at constant rate of 5% per annum in
perpetuity?
d. constant dividend for first five years and then, share is sold at the price of ₹ 20?
Solution:
D1 2.50
(a) P0 =   ₹ 12.50
Ke 0.20
D1
(b) P0 =
Ke  g
2.50  1.05
=
0.20  0.05
= 17.5
(c) Calculation of P0:
Year CF’S PVAF @ 20% DCF
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Adish Jain CA CFA
D1 – 5 2.5 2.991 7.48

2.625
TV5 = 17.5 0.402 7.03
0.20 - 0.05
14.51
(d) Calculation of P0:
Year CF’S PVAF @ 20% DCF
D1 – 5 2.5 2.991 7.48
TV5 20 0.402 8.04
15.52
QUESTION 17:
M 19 | M 14
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.
Solution:
D1 = 5 (1.1) = 5.5
D2 = 5.5 (1.1) = 6.05
D3 = 6.05 (1.1) = 6.655
D4 = 6.655 (1.05) = 6.988
Ke = 15%
P0 = PV (Dividends) + PV (Terminal Value)
6.988
= 5.5 (0.870) + 6.05 (0.756) + 6.655 (0.658) + (0.658)
0.15 - 0.05
= 59.72
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 18:
M 16
15
Adish Jain CA CFA
XYZ Ltd. paid a dividend of ₹ 2 for the current year. The dividend is expected to grow at 40% for the
next 5 years and at 15% per annum thereafter. The return on 182 days T-bills is 11% per annum and
the market return is expected to be around 18% with a variance of 24%.
The co-variance of XYZ's return with that of the market is 30%. You are required to calculate the
required rate of return and intrinsic value of the stock.
Solution:
Covariance(s,m)
Calculation of  =
Variance(m)
= 30 = 1.25
24
Calculation of Ke = 11 + 1.25 (18 - 11)
= 19.75%
Calculation of Price:
Year Dividend PVAF @ 19.75% DCF
1 2.8 0.8351 2.34
2 3.92 0.6973 2.73
3 5.49 0.5823 3.2
4 7.68 0.4863 3.73
5 10.76 0.4061 4.37
12.37
5 = 260.42 0.4061 105.76
0.1975 - 0.15
122.13
QUESTION 19:
M 23 | N 20 | M 19
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 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
a. To calculate the intrinsic value of the share of LX Ltd.
b. 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:
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Adish Jain CA CFA
a) Intrinsic value of shares:

Year Growth Dividend / TV PVF @ 20% DCFs
1 20% 4 0.833 3.332
2 20% 4.8 0.694 3.331
3 20% 5.76 0.576 3.335
4 20% 6.91 0.482 3.331
5 19% 8.23 0.402 3.308
6 18% 9.71 0.335 3.253
7 17% 11.36 0.279 3.169
11.36 × (1.16)
7 - = 329.44 0.279 91.914
0.20 - 0.16
114.973
Self-note: The question is silent on the time period during which the growth will fall from 20%
to 16%. In the absence of specific information, hint can be taken from number of years for
which PVIF are given and accordingly, fall in growth is assumed to be 1% every year.
b) Since, MPS (₹ 112) < IV (₹ 114.97)
therefore, it is worth to purchase at this price.
QUESTION 20:
M 23
An investor is considering purchasing equity shares of Alpha Ltd., whose current Market price is `
172.45. The company is proposing a dividend of ` 6 for the year ending 31st March, 2024. Alpha Ltd.
is expected to grow @ 20 percent per annum for the next four years. Thereafter, the growth, over
the next three years, will decline linearly by 100 basis points per annum. Thereafter, it will stabilize
at a certain growth rate per annum infinitely. The required rate of return for the investor is 20%.
Dividend value is to be taken in 2 decimal points only.
You are required:
a. To calculate the stable growth rate of Alpha Ltd. after the end of 7 years.
b. To advise whether it is worth to purchase the share at this price if the investor has a stable target
growth rate of 15% per annum.
Period 1 2 3 4 5 6 7
PVIF (20%, n) 0.8333 0.6944 0.5787 0.4823 0.4019 0.3349 0.2791
Solution:
a) Stable growth rate after the end of 7 years.
PV of dividends from years 1 to 7:
Year Growth Dividend / TV PVF @ 20% DCFs
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Adish Jain CA CFA
1 20% 6 0.8333 5.00

2 20% 7.2 0.6944 5.00
3 20% 8.64 0.5787 5.00
4 20% 10.37 0.4823 5.00
5 19% 12.34 0.4019 4.96
6 18% 14.56 0.3349 4.88
7 17% 17.04 0.2791 4.76
34.60
17.04 × (1 + g)
PV of terminal value =  0.2791
0.20 - g
Now, P0 = PV (Dividends) + PV (Terminal Value)
17.04 × (1 + g)
172.45 = 34.6 +  0.2791
0.20 - g
g = 16%
Thus, the stable growth rate after the end of the 7 years shall be 16%.
b) Since above calculated growth rate is more than target growth rate it is worth to purchase the
share.
QUESTION 21:
N 15 | RTP
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:
a) The earnings and dividend will grow at 25% for the next two years
b) Earnings are likely to grow at the rate of 10% from 3rd year and onwards.
c) Further, 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
18
Adish Jain CA CFA
a. Expected Market Price per Share

b. P/E Ratio
Solution:
a) Expected Market Price per Share:
Year EPS CFs PVAF DCFs
2015 12 4.8 0.87 4.176
2016 15 6 0.756 4.536
16.5 × 50%
2016 16.5 = 165 0.756 124.74
0.15 - 0.10
133.45
b) PE Ratio = 133.45/9.6 = 13.90
QUESTION 22:
N 20 | PM
Seawell 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 2004 to 2008, during this period the dividend payout ratio is expected to
remain unchanged. After 2008. The earnings growth rate is expected to drop to a stable rate of 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%.
a. What is the expected price of the stock at the end of 2008?
b. What is the value of the stock, using the two – stage dividend discount model?
Solution:
Calculation of Ke: Before 2008: = 6.25 + 1.40 (5.5)
= 13.95%
After 2008: = 6.25 + 1.10 (5.5)
= 12.3%
0.69
Existing Dividend Payout Ratio = = 32.86%
2.1
The dividends from 2003 onwards can be estimated as:
Year Growth EPS Payout DPS PVAF @ 13.95% DCFs
2004 15% 2.415 32.86% 0.794 0.878 0.697
2005 15% 2.777 32.86% 0.913 0.770 0.703
2006 15% 3.194 32.86% 1.050 0.676 0.710
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Adish Jain CA CFA
2007 15% 3.673 32.86% 1.207 0.593 0.716

2008 15% 4.224 32.86% 1.388 0.521 0.723
3.549
D2009
a) Expected Share Price as on 2008 (P2008) =
Ke - g
4.224 × (1.06) × 65%
=
0.123 - 0.6
= 46.19
b) Expected Share Price Today: = 3.549 + 46.19  0.521
= 27.61
QUESTION 23:
N 19
The 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 years 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 years 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
PVF @ 17% 0.855 0.731 0.625 0.534 0.456 0.39 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:
Year Growth EPS Payout DPS / TV PVAF DCFs
1 40% 5.60 10% 0.56 0.855 0.48
2 40% 7.84 10% 0.78 0.731 0.57
3 40% 10.98 10% 1.10 0.625 0.69
4 40% 15.37 10% 1.54 0.534 0.82
5 40% 21.52 10% 2.15 0.456 0.98
6 34% 28.84 18% 5.19 0.390 2.02
7 28% 36.92 26% 9.60 0.333 3.20
8 22% 45.04 34% 15.31 0.285 4.36
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Adish Jain CA CFA
9 16% 52.25 42% 21.95 0.244 5.36

10 10% 57.48 50% 28.74 0.209 6.01
28.74 × (1.1)
10 - = 451.63 0.209 94.39
0.17 - 0.1
118.88
Since the Intrinsic Value of Equity share is less than current market price, it is not advisable to invest
in the same.
QUESTION 24:
RTP N 10
The Digital Electronic System Corporation (DESC) pays no cash dividends currently and is not
expected to for the next five years Its latest EPS was €10, all of which was reinvested in the company.
The firm’s expected ROE for the next five years is expected to be 20% per year, and during this time
it is also expected to continue to reinvest all of its earnings. It is expected that starting six years from
now the DESC’s ROE on new investments is expected to fall to 15%, and it is expected that the
corporation shall start paying out 40% of its earnings in form of cash dividends, which it will continue
to do forever after. DESC’s market capitalization rate is 15% per year.
a. Using DDM model, what is the value of DESC’s share today?
b. Now suppose that the current market price of share is equal to as computed in (a) above, then
what do you expect to happen to its price over the next year? The year after?
c. If you are expecting that DESC to pay out only 20% of earning starting in year 6 then, how your
estimates will be affected?
Solution:
(a) Growth (G1): RR0  ROE1
Year 0 to 5: 100%  20% = 20%
Year 6: 100%  15% = 15%
Year 7 and onwards: 60%  15% = 9%
Expected EPS for future years:
EPS5 = 10  (1 + 0.20)5 = € 24.88
EPS6 = 24.88 (1 + 0.15) = € 28.61
D6 = 28.61  40% = € 11.44
D6 1
Hence, value of DESC’s share now =[ ]
ke - g (1 + Ke )5
11.44 1
=[ ]
15% - 9% 1.155
= € 94.76
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Adish Jain CA CFA
(b) The price should rise by 15% per year until year 6. Since there is no dividend, the entire return
must be in capital gains.
(c) There will not be any change in the value because ROE = Ke.
Revised growth rate for year 7 & onwards = (1 – 20%)  15% = 12%
D6 = 28.61  20% = 5.72
D7 = 28.61  (1.12)  20% = € 6.41
D6 1
Hence, value of DESC’s share now =[ ]
ke - g (1 + Ke )5
5.72 1
=[ ]
15% - 12% 1.155
= € 94.80
QUESTION 25:
M 16 | RTP
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 the 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 at least ₹ 2,000 p.a. from this
investment.
Required:
a. EVALUATE whether the market value of the share is affected by the decision of the Board.
b. RECOMMEND how the investor can maintain his target receipt from the investment for first 3
years and improved income thereafter, given that the cost of capital of the firm is 8%.
Solution:
(a) MV of share before declaring project
D1
P0 =
Ke  g
= 2  1 .06
 ₹ 106
0 . 08  0 . 06
MV of share after declaring project
D4
P0 =  PVF (8%, 3 years)
Ke  g
2 .5
=  0.794
0.08  0.07
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Adish Jain CA CFA
= 198.46
MV of share will increase from ₹ 106 to ₹ 198.46 due to decision of the board
(b) Number of shares investor must sell to maintain target receipt:
Year Expected Market Price No. of Shares to sell
1 198.46  1.08 = 214.34 2,000/214.34 = 10 shares
2 198.46  1.08 = 231.48
2
2,000/231.48 = 9 shares
3 198.46  1.083 = 250 2,000/250 = 8 shares
Income to be received from sale of shares:
Year No of shares sold MP Total Receipt
1 10 214.34 2143.40
2 9 231.48 2083.32
3 8 250 2000
Calculation of Improved dividend Income:
No. of shares left = 1000 – (9 + 8 + 10)
= 973
Income to be received = 973  2.5
= 2432.5
QUESTION 26:
N 17
Rahim Enterprises is a manufacturer and exporter of woollen garments to European countries. Their
business is expanding day by day and in the previous financial year the 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 is ₹ 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:
Impact on dividend:
Total earnings before the new project:
Total Earnings: (25  10,00,000) ₹ 2,50,00,000
Total earnings after the new project:
For 1st Year:
Existing Earnings 2,50,00,000
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Adish Jain CA CFA
Less: Cost of new investment 1,75,00,000

Dividend Payment 75,00,000
No of Shares  10,00,000
Dividend per share 7.5 per share
For 2nd year onwards:

Existing Earnings 2,50,00,000
Add: Cash from new project 50,00,000
Dividend Payment 3,00,00,000
No of Shares  10,00,000
Dividend per share 30 per share
The dividend payment will charge from existing ₹ 25 per share to ₹ 7.5 per share in first year and ₹
30 in second years onwards.
Impact on Share Price:

Before new Project: ₹ 125
After new Project:
D1
Calculation of Ke = g
P0
= 25  0
125
= 20%
D1 D2 1
Share price (P0) = + 
( 1 + Ke ) Ke ( 1 + Ke )
7.5 30 1
= + 
1.20 0.20 1.20
= 131.25
The share price will increase from of 125 to 131.25
QUESTION 27:
N 19
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.
24
Adish Jain CA CFA
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 years 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:
a. Would you purchase RK Ltd. equity at this time based on your one year forecast?
b. 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:
a) Calculation of profit of company:
Division Net Profit
A (₹ 50 crore x 10% x 5%) 0.25
B (₹ 20 crore x 30% x 8%) 0.48
C (₹ 8.5 crore x 2% x 10%) 0.017
Net Profit 0.747
÷ Number of shares 0.03
EPS of year 1 24.9
 PE Ratio 10
Market Price at year 1 249
 PVIF 0.847
PV of expected price 210.90
I would NOT like to purchase the share as the expected market price of shares is less than its
current price of ₹ 250.
b) If Earning is expected to grow @ 15%
Method 1: Logical Solution
Year EPS DPS PVAF
1 24.9 - 0.847 0
2 28.64 - 0.718 0
3 32.93 32.93  30% = 9.88 0.609 6.02
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Adish Jain CA CFA
9.98 × (1.15)
3 - = 378.73 0.609 230.65
0.18 - 0.15
236.67
The maximum price I would be willing to pay for the share shall be ₹ 236.67
Method 2: Solution by ICAI
Year EPS (₹) Dividend (₹) PVF@18% PV (₹)
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
0.18 - 0.15
PV of the Market Price after 5 years = ₹ 575.77  0.437 = ₹ 251.61
Total PV of Inflows = ₹ 20.22 + ₹ 251.61 = ₹ 271.83
Thus, the maximum price I would be willing to pay for the share shall be ₹ 271.83.
QUESTION 28:
M 10 | RTP
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 for purchase and sale of shares
are estimated to be 5% of the market price. He expects a minimum return of 12% per annum.
Should Mr. A buy the share? If so, what maximum price should he pay for each share? Assume no
tax on dividend income and capital gain.
Solution:
Year CF’s PVAF@12%
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
26
Adish Jain CA CFA
7 24 0.452 10.85
7 900  0.95  1.2 = 1026 0.452 463.75
Value of Share 563.68
Less: Cost of share (500 + 5%) (525)
Gain 38.68
Since Mr. A is gaining he should buy the share
Let the maximum Price Mr. A should pay = X
Total cost with incidental expense = 1.05X
Since, Mr. A is getting maximum benefit of ₹ 563.68. It means that he can pay maximum of ₹ 563.68
including any incidental expense. Therefore,
1.05 X = 563.68
X = 536.84
QUESTION 29:
SM | RTP
Piyush Lonker and Associates presently pay a dividend of Re. 1.00 per share and has a share price of
₹ 20.00.
a. If this dividend were expected to grow at a rate of 12% per annum forever, what is the firm’s
expected or required return on equity using a dividend – discount model approach?
b. Instead of this situation in part (i) suppose that the dividends were expected to grow at a rate of
20% per annum for 5 years and 10% per year thereafter. Now what is the firm’s expected, or
required, return on equity?
Solution:
a) Firm’s Expected or Required Return on Equity using a dividend discount model approach:
D1 = D0 (1 + g)
= 1 (1 + 0.12) or ₹ 1.12
P0 = ₹ 20
g = 12% per annum
D1
Ke = +g
P0
1.12
= + 12%
20
= ₹ 17.6%
(ii) Firm’s Expected or Required Return on Equity if dividends were expected to grow at a rate of
20% per annum for 5 years and 10% per year thereafter:
P0 = PV (Dividends) + PV (Terminal Value)
27
Adish Jain CA CFA
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 - 0.10 (1 + ke )5
We will have to calculate the value of Ke using trial and error method and then use
interpolation to find precise Ke:
If, Ke = 18% --------------> P0 = 20.23
Ke = ? --------------> P0 = 20 (given P0)
Ke = 19% --------------> P0 = 17.89
Using interpolation,
Ke - 18 20 - 20.23
=
19 - 18 17.89 - 20.23
Ke = 18.10%
QUESTION 30:
Perfect Solutions Ltd is growing at an extra ordinary growth rate of 20% for some years However, it
is not expected to continue to future and it will fall linearly to ordinary growth rate of 6% in a period
of 8 years It distributed dividend of ₹ 50 last year. Calculate the value of share using H model if
opportunity cost is 12%.
Solution:
D 0 1 + gn D0 gs - gn × H
Value of Share: = +
Ke - gn Ke - gn
50 1  0.06  50 0.20  0.06 4
= 
0.12  0.06 0.12  0.06
= ₹ 1,350
QUESTION 31:
Alcatel is a telecommunications firm, paid dividends per share of ₹ 0.72 on earnings per share of ₹
1.25 in 2019. The firm’s earnings per share had grown at 12% over the prior 5 years but the growth
rate is expected to decline linearly over the next 10 years to 5%, while the payout ratio remains
unchanged. The beta for the stock is 0.8, the risk-free rate is 5.1% and the market risk premium is
4%. Determine the value of share based on H Model.
Solution:
Calculation of cost of equity = Rf +  (Rm – Rf)
= 5.1 + 0.80 (4)
= 8.3%
28
Adish Jain CA CFA
D0 1 + gn D0 gs - gn × H
Value of Share: =
Ke - g n
+ Ke - gn
0.721  0.05 0.720.12  0.05 5
= 
0.083  0.05 0.083  0.05
= ₹ 30.55
29
Adish Jain CA CFA
B. Cash Flow Based Valuation Models

QUESTION 32:
N 19
Mr. X, a financial analyst, intends to value the business of PQR Ltd. in terms of the future cash
generation capacity. He has projected the following after tax cash flows:
Year: 1 2 3 4 5
Cash flows (₹ in lakh) 1,760 480 640 860 1,170
It is further estimated that beyond 5th year, cash flows will perpetuate at a constant growth rate of
8% per annum, mainly on account of inflation. The perpetual cash flow is estimated to be ₹ 10,260
lakhs at the end of the 5th year. Required
a. What is the value of the firm in terms of expected future cash flows, if the cost of capital of the
firm is 20%?
b. The firm has outstanding debts of ₹ 3,620 lakh and cash / bank balance of ₹ 2,710 lakhs. Calculate
the shareholder value per share if the number of outstanding shares is 151.50 lakh.
c. The firm has received a takeover bid from XYZ Ltd. of ₹ 225 per share. Is it a good offer?
[Given: PVIF at 20% for year 1 to year 5: 0.833, 0.694, 0.579, 0.482, 0.402]
Solution:
(a) Calculation of value of firm
Year CF’s PVAF DCFs
1 1760 0.833 1466.08
2 480 0.694 333.12
3 640 0.579 370.56
4 860 0.482 414.52
5 1170 0.402 470.34
10260 × 1.08
5 = 92,340 0.402 37120.68
0.20 - 0.08
40175.3
(b) Shareholder value per share:
Value of Firm 40175.3
Less: Value of debt (3620)
Value of Equity 36555.3
 No. of share 151.50
Shareholder Value per share 241.29
(c) Since, value of equity share is ₹ 241.29
Therefore, takeover bid of ₹ 225 per share is not a good offer.
30
Adish Jain CA CFA
Self-note: Cash & cash equivalent has nothing to do in the calculation of value of equity from the value
of firm. It is of considered in the calculation of enterprise value and not here.
QUESTION 33:
MTP N 16
Calculate the value of share from the following information:
Profit after Tax (PAT) of the company € 2900 million
Equity capital of company € 13,000 million
Par value of share € 40 each
Debt to Equity ratio of the company 1:3
Debt to Equity ratio of the proxy company 1:2
Beta of proxy company 0.20
Long run growth rate of the company 8%
Risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share € 47
Depreciation per share € 39
Change in Working capital € 3.45 per share
Assume corporate tax rate to be 30% and Beta of Debt as zero.
Solution:
WN 1: Calculation of Ke
Step 1: Convert Equity Beta of proxy firm to its Asset Beta
E
A = E 
E + D (1 - t)
2
A = 0.2 
2 + 1 (1 - 0.3)
A = 0.148
It can be used as beta for proxy company
Step 2: Calculate Equity Beta of our company using Asset Beta of proxy company:
E
A = E 
E + D (1 - t)
3
0.148 = E 
3 + 1 (1 - 0.3)
E = 0.183
31
Adish Jain CA CFA
Step 3: Calculate Ke using CAPM

Ke = Rf +  (Rm – Rf)
= 8.7 + 0.183 (10.3 – 8.7)
= 8.99%
WN 2: Calculation of FCFE
13 ,000
No. of shares = = 32.5 million
40
€2900
EPS = = € 8.923
325
Now, calculating FCFE:
EPS 8.9231
+ Depreciation 39
– WC Investment (3.45)
– Capital Expenditure (47)
+ Borrowings 2.8625 [ ¼ or 25% of (47 – 39 + 3.45)]
FCFE 0.3356
FCFE 1  g 
Value of equity =
Ke  g
0.3356  (1.08)
=
0.0899 - 0.08
= 36.61
Value of equity share is ₹ 36.61
QUESTION 34:
M 22 | M 16 | M 09 | RTP
On the basis of the following information, calculate the value of share:
Profit after tax of the company ₹ 290 Cr.
Equity capital of company ₹ 1300 Cr.
Par value of share ₹ 40 each
Debt ratio of company (Debt/ Debt + Equity) 27%
Long run growth rate of the company 8%
Beta 0.1; risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share ₹ 47
32
Adish Jain CA CFA
Depreciation per share ₹ 39

Change in Working capital ₹ 3.45 per share
Solution:
Number of Shares = 1300/40 = 32.5 Cr.
290 Cr
EPS = = € 8.923
32.5 Cr
Calculating FCFE:
EPS 8.923
+ Depreciation 39
– WC Investment (3.45)
– Capital Expenditure (47)
+ Borrowings 3.0915 [ 27% of (47 – 39 + 3.45)]
FCFE 0.5645
Calculation of Ke:
= Rf +   (Rm – Rf)
= 8.7 + 0.1  (10.3 – 8.7)
= 8.86%
FCFE 1  g 
Value of share =
Ke  g
0.5645 × 1.08
=
0.0886 - 0.08
= 70.89
QUESTION 35:
N 22 | M 14
Following information is given in respect of WXY Ltd., which is expected to grow at a rate of 20% p.a.
for the next three years, after which the growth rate will stabilize at 8% p.a. normal level, in
perpetuity.
For the year ended March 31, 2014
Revenues ₹ 7,500 Crores
Cost of Goods Sold (COGS) ₹ 3,000 Crores
Operating Expenses ₹ 2,250 Crores
Capital Expenditure ₹ 750 Crores
Depreciation (included in Operating Expenses) ₹ 600 Crores
33
Adish Jain CA CFA
During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at 20% p.a.
and capital expenditure net of depreciation will grow at 15% p.a. From year 4 onwards, i.e. normal
growth period revenues and EBIT will grow at 8% p.a. and incremental capital expenditure will be
offset by the depreciation. During both high growth & normal growth period, net working capital
requirement will be 25% of revenues.
The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%.
Corporate Income Tax rate will be 30%.
Required:
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC methodology.
Solution:
Calculation of Working Capital
Year Revenue WC (25% of Revenue) Increase in WC
0 7,500 1,875
1 9,000 2,250 375
2 10,800 2,700 450
3 12,960 3,240 540
4 13,996.8 3,499.2 259.2
Calculation of Free Cash flows to firm
Year 1 2 3 4
EBIT 2,700 3240 3,888.00 4,199.04
Less: Tax @ 30% -810 -972 -1,166.40 -1,259.71
EAT 1,890 2268 7,721.40 2,939.33
Less:  in WC -375 -450 -540.00 -259.20
Less: Capex – Depreciation -172.5 -198.38 -228.13 -
FCFF 1,342.50 1,619.62 1,953.47 2,680.13
Calculation of PV of Cash Flows
Year FCFE/TV PVIF DCFs
1 1,342.50 0.8696 1,167.44
2 1,619.62 0.7561 1,224.59
3 1,953.47 0.6575 1,284.41
2680.13
3 = 38287.57 0.6575 25,174.08
0.15 - 0.08
28,850.52
Value of the Firm = ₹ 28,850.52 crores
QUESTION 36:
34
Adish Jain CA CFA
M 22 | M 10 | RTP
Following information is available in respect of XYZ Ltd. which is expected to grow at a higher rate
for 4 years after which growth rate will stabilize at a lower level:
Base year information:
Revenue - ₹ 2,000 crores
EBIT - ₹ 300 crores
Capital expenditure - ₹ 280 crores
Depreciation - ₹ 200 Crores
Information for high growth and stable growth period are as follows:
High Growth Stable Growth
Growth in Revenue & EBIT 20% 10%
Growth in capital expenditure and 20% Capital expenditure are offset
depreciation by depreciation
Risk free rate 10% 9%
Equity beta 1.15 1
Market risk premium 6% 5%
Pre tax cost of debt 13% 12.86%
Debt equity ratio 1 : 1 2 : 3
For all time, working capital is 25% of revenue and corporate tax rate is 30%.
What is the value of the firm?
Solution:
Calculation of Change in working Capital
Year Revenue WC @ 25% Increase in WC
0 2000 500
1 2400 600 100
2 2880 720 120
3 3456 864 144
4 4147.2 1036.8 172.8
5 4561.92 1140.48 103.68
Calculating FCFF
Year 1 2 3 4 5
Revenue 2400 2880 3456 4147.2 4561.92
EBIT 360 432 518.4 622.08 684.29
Less: Tax @ 30% (108) (129.6) (155.52) (186.62) (205.29)
EAT 252 302.4 362.88 435.46 479
Add: Depreciation 240 288 345.6 414.72 –
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Adish Jain CA CFA
Less: Capital Expenditure (336) (403.2) (483.84) (580.61) –

Less: WC Investment (100) (120) (144) (172.8) (103.68)
FCFF 56 67.2 80.64 96.77 375.32
Calculation of KC
High Growth Stable Growth
Ke = 10 + 1.15  (6) = 16.9% = 9+ 1  (5) = 14%
Kd = 13  (1 - 0.30) = 9.1% = 12.86  (1 - 0.30) = 9%
16.9  1 9.1  1 = 14  3  9  2 = 12%

K0 =  = 13%
2 2 5 5
Calculation of Value of firm

Year CF’S PVAF@13% DCFs
1 56 0.885 49.56
2 67.2 0.783 52.62
3 80.64 0.693 55.88
4 96.77 0.613 59.32
375.32
4 = 18,766 0.613 11503.56
0.12 - 0.10
11,720.94
QUESTION 37:
N 06 | RTP
AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The valuation is to be based
on the recommendation of merchant bankers and the consideration is to be discharged in the form
of equity shares to be issued by AB Ltd. As on 31.3.2006, the paid up capital of AB Ltd. consists of 80
lakhs shares of ₹10 each. The highest and the lowest market quotation during the last 6 months were
₹570 and ₹430. For the purpose of the exchange, the price per share is to be reckoned as the average
of the highest and lowest market price during the last 6 months ended on 31.3.06.
XY Ltd.’s Balance Sheet as at 31.3.2006 is summarised below:
₹ Lakhs
Sources
Share Capital
20 lakhs equity shares of ₹10 each fully paid 200
10 lakhs equity shares of ₹10 each, ₹5 paid 50
Loans 100
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Adish Jain CA CFA
Total 350
Uses
Fixed Assets (Net) 150
Net Current Assets 200
Total 350
An independent firm of merchant bankers engaged for the negotiation, have produced the following
estimates of cash flows from the business of XY Ltd.:
Year ended By way of ₹ lakhs
31.3.07 After tax earnings for equity 105
31.3.08 ------ do ------ 120
31.3.09 ------ do ------ 125
31.3.10 ------ do ------ 120
31.3.11 ------ do ------ 100
Terminal Value estimate 200
It is the recommendation of the merchant banker that the business of XY Ltd. may be valued on the
basis of the average of (i) Aggregate of discounted cash flows at 8% and (ii) Net assets value.
Present value factors at 8% for years:
1-5: 0.93 0.86 0.79 0.74 0.68
a. Calculate the total value of the business of XY Ltd.
b. The number of shares to be issued by AB Ltd.; and
c. The basis of allocation of the shares among the shareholders of XY Ltd.
Solution:
Price/share of AB Ltd. for determination of number of shares to be issue = (₹ 570 + ₹ 430)/2 = ₹ 500
Value of XY Ltd based on future cash flow 592.40 lakhs
(105 x 0.93) + (120 x 0.86) + (125 x 0.79) + (120 x 0.74) + (300 x 0.68)
Value of XY Ltd based on net assets 250.00 lakhs
Average value of XY Ltd (592.40 + 250)/2 421.20 lakhs
Price per Share of AB Ltd 500
No. of shares in AB Ltd to be issued (421.2 Lakhs ÷ 500) 84240
Basis of allocation of shares
Fully paid equivalent shares in XY Ltd. (20 + 5) lakhs 2500000
Distribution to fully paid shareholders 84240x20/25 67392
Distribution to partly paid shareholders 84240-67392 16848
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Adish Jain CA CFA
QUESTION 38:
N 14 | RTP | M 18 | N 10 | SM
The valuation of Hansel Limited has been done by an investment analyst. Based on an expected free
cash flow of ₹ 54 lakhs for the following year and an expected growth rate of 9 percent, the analyst
has estimated the value of Hansel Limited to be ₹ 1800 lakhs. However, he committed a mistake of
using the book values of debt and equity.
The book value weights employed by the analyst are not known, but you know that Hansel Limited
has a cost of equity of 20 percent and post tax cost of debt of 10 percent. The value of equity is thrice
its book value, whereas the market value of its debt is nine-tenths of its book value. What is the
correct value of Hansel Ltd?
Solution:
Calculation of Ko:
FCFF1
Value of firm =
Ko - g
54
1800 =
Ko - 0.09
Ko = 12%
Calculation of incorrect weights used in calculation by analyst
K0 = Ke  We + Kd  Wd
12% = 0.20  We + 0.10  (1 – We)
We = 0.2
Wd = 1 – We = 0.8
Calculation of correct Ko using correct weights:
Correct We = 0.2  3 = 0.60
Correct Wd = 0.8  9/10 = 0.72
0.60 0.20  0.72 0.10
Correct Ko =  14.55%
1.32
Correct value of firm:
54
=
0.1455 - 0.09
= ₹ 974.73 lakhs
QUESTION 39:
RTP
38
Adish Jain CA CFA
BRS Inc deals in computer and IT hardwares and peripherals. The expected revenue for the next 8
years is as follows:
Year Sales Revenue ($ Million)
1 8
2 10
3 15
4 22
5 30
6 26
7 23
8 20
Summarized financial position as on 31st March 2012 was as follows:
Liabilities Amount Assets Amount
Equity Stock 12 Fixed Assets (Net) 17
12% Bond 8 Current Assets 3
20 20
Additional Information:
a) Its variable expenses is 40% of sales revenue and fixed operating expenses (cash) are
estimated to be as follows:
Period Amount ($ Million)
1 – 4 years 1.6
5 – 8 years 2
b) An additional advertisement and sales promotion campaign shall be launched requiring
expenditure as per following details:
1 years 0.50
2 – 3 years 1.50
4 – 6 years 3.00
7 – 8 years 1.00
c) Fixed assets are subject to depreciation at 15% as per WDV method.
d) The company has planned additional capital expenditures (in the beginning of each year) for
the coming 8 years as follows:
1 0.50
2 0.80
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Adish Jain CA CFA
3 2.00
4 2.50
5 3.50
6 2.50
7 1.50
8 1.00
e) Investment in working Capital is estimated to be 20% of Revenue.
f) Applicable tax rate for the company is 30%.
g) Cost of Equity is estimated to be 16%
h) The Free Cash Flow of the firm is expected to grow at 5% per annum after 8 years
With above information you are require to determine the:
(i) Value of Firm
(ii) Value of Equity
Solution:
(i) Value of Firm
Determination of Weighted Average Cost of Capital
Cost (%) Proportions Weights Weighted Cost
Equity Stock 16 12/20 0.60 9.60
12% Bonds 12% (1-0.30) = 8.40 8/20 0.40 3.36
12.96ay 13
Schedule of Fixed Assets & Depreciation
$ Million
Year Opening FA Addition Closing FA Depreciation @ 15%
1 17.00 0.50 17.50 2.63
2 14.87 0.80 15.67 2.35
3 13.32 2.00 15.32 2.30
4 13.02 2.50 15.52 2.33
5 13.19 3.50 16.69 2.50
6 14.19 2.50 16.69 2.50
7 14.19 1.50 15.69 2.35
8 13.34 1.00 14.34 2.15
Determination of Investment
$ Million
Investment Required Existing Additional
Year
For Capital CA (20% of Total Investment in Investment
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Adish Jain CA CFA
Expenditure Revenue) CA required

1 0.50 1.60 2.10 3.00 0.00
2 0.80 2.00 2.80 2.50* 0.30
3 2.00 3.00 5.00 2.00** 3.00
4 2.50 4.40 6.90 3.00 3.90
5 3.50 6.00 9.50 4.40 5.10
6 2.50 5.20 7.70 6.00 1.70
7 1.50 4.60 6.10 5.20 0.90
8 1.00 4.00 5.00 4.60 0.40
* Balance of CA in Year 1 ($3 Million) – Capital Expenditure in Year 1($ 0.50 Million)
** Similarly balance of CA in Year 2 ($2.80) – Capital Expenditure in Year 2($ 0.80 Million)
Determination of Present Value of Cash Inflows

$ Million
Particulars Years
1 2 3 4 5 6 7 8
Revenue (A) 8.00 10.00 15.00 22.00 30.00 26.00 23.00 20.00
Expenses
Variable Costs 3.20 4.00 6.00 8.80 12.00 10.40 9.20 8.00
Fixed cash op. cost 1.60 1.60 1.60 1.60 2.00 2.00 2.00 2.00
Advertisement Cost 0.50 1.50 1.50 3.00 3.00 3.00 1.00 1.00
Depreciation 2.63 2.35 2.30 2.33 2.50 2.50 2.35 2.15
Total Expenses (B) 7.93 9.45 11.40 15.73 19.50 17.90 14.55 13.15
EBIT (C) = (A) - (B) 0.07 0.55 3.60 6.27 10.50 8.10 8.45 6.85
Less: Taxes @ 30% 0.02 0.16 1.08 1.88 3.15 2.43 2.53 2.06
NOPAT 0.05 0.39 2.52 4.39 7.35 5.67 5.92 4.79
Add: Depreciation 2.68 2.74 4.82 6.72 9.85 8.17 8.27 6.94
Less: Capital & CA Inv. 0 0.30 3.00 3.90 5.10 1.70 0.90 0.40
Free Cash Flow 2.68 2.44 1.82 2.82 4.75 6.47 7.37 6.54
PVF@13% 0.885 0.783 0.693 0.613 0.543 0.480 0.425 0.376
PV of CFs 2.371 1.911 1.261 1.729 2.579 3.106 3.132 2.46
Total Present Value of CFs of 8 years = $ 18.549 million
FCFF9
PV of Terminal value (TV8) at 8th year: =  PVIF (13%,8)
ko - g
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Adish Jain CA CFA
$6.54 (1.05)
=  0.376
0.13 - 0.05
= $32.2749 million
Value of Firm = Total PV of CFs of 8 years + PV of TV8
= $ 18.549 million + $ 32.2749 million
= $ 50.8239
(ii) Value of Equity
$ Million
Total Value of Firm 50.8239
Less: Value of Debt 8.0000
Value of Equity 42.8239
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Adish Jain CA CFA
C. NPV Based Questions of Valuation

QUESTION 40:
RTP M 19
The directors of Implant Inc. wishes to make an equity issue to finance a $ 10 m (million) expansion
scheme which has an expected Net Present Value of $2.2m and to re-finance an existing $6 m 15%
Bonds due for maturity in 5 years time. For early redemption of these bonds there is a $3,50,000
penalty charges. The Co. has also obtained approval to suspend these pre-emptive rights and make
a $15 m placement of shares which will be at a price of $0.5 per share. The floatation cost of issue
will be 4% of Gross proceeds. Any surplus funds from issue will be invest in IDRs which is currently
yielding 10% per year.
The Present capital structure of Co. is as under. ($ ‘000)
Ordinary Share ($1 per share) 7,000
Share Premium 10,500
Free Reserves 25,500
43,000
15% Term Bonds 6,000
11% Debenture (2012-2020) 8,000
57,000
Current share price is $2 per share and debenture price is $ 103 per debenture. Cost of capital of Co.
is 10%. It may be further presumed that stock market is semi-strong form efficient and no
information about the proposed use of funds from the issue has been made available to the public.
You are required to calculate expected share price of company, once full details of the placement
and to which the finance is to be put, are announced.
Solution:
Calculation of PV of savings in interest and redemption value
Interest 60,00,000  15%  3.791 34,11,900
Redeem value 60,00,000  0.621 37,26,000
Total Outflow 71,37,900
Expected Share price of company:
Current value of the company (70,00,000  2) 1,40,00,000
Add: Funds Raised 1,50,00,000
Less: Floatation Cost -6,00,000
Add: NPV of expansion scheme 22,00,000
Add: Net Saving due to early redemption of bonds
PV of savings in Future Interest & RV 71,37,900
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Adish Jain CA CFA
Less: Redemption Outflow now -60,00,000

Less: Penalty Charges -3,50,000 7,87,900
Revised value of Co. 3,13,87,900
÷ No. of Shares(15 ÷ 0.5 + 7) 3,70,00,000
Expected share price of the company 0.848
QUESTION 41:
N 20 | N 13
M/S. Roly Ltd. wants to acquire M/S. Poly Ltd. The following is the Balance Sheet of Poly Ltd. as on
31st March, 2020:
Equity Capital (₹ 10 per share) 10,00,000 Cash 20,000
Retained Earnings 3,00,000 Debtors 50,000
12% Debentures 3,00,000 Inventories 2,00,000
Creditors and other liability 3,20,000 Plant & Machinery 16,50,000
19,20,000 19,20,000
Shareholders of Poly Ltd. will get one share of Roly Ltd. at current market price of 20 for every two
shares. External liabilities are expected to be settled at a discount of 20,000. Sundry debtors and
Inventories are expected to realise 2,00,000.
Poly Ltd. will run as an independent unit. Cash Flow After Tax is expected to be ₹ 4,00,000 per annum
for next 6 years Assume the disposal value of the plant after 6 years will be ₹ 1,50,000.
Poly Ltd. requires a return of 14%.
n 1 2 3 4 5 6
PVAF (14%, n) 0.877 0.769 0.675 0.592 0.519 0.456
Advise the Board of Directors on the financial feasibility of the Proposal.
Solution:
Calculation of Purchase Consideration
Issue of Share 50000 x ₹ 20 10,00,000
Add: External Liabilities settled 3,00,000
Add: 12% Debentures settled 3,00,000
16,00,000
Less: Debtors and Inventories realised 2,00,000
Less: Cash Balance realised 20,000
13,80,000
PV of Future Cash Flows from Poly Ltd:
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Adish Jain CA CFA
= Annual CF  PVAF (14%, 6 years) + Disposal Value  PVAF (14%, 6th year)
= 4,00,000  3.888 + 1,50,000  0.456
= 16,23,600
NPV of the proposal = PV of future cash inflows – Purchase consideration
= 16,23,600 – 13,80,000
= 2,43,600
Advise: The project is financially feasible
Self-note: Unlike other assets & liabilities, question will not specify about realisation of cash of target
company. Keep in mind to deduct it while calculating purchase consideration. Also, question is silent
about treatment of debentures, however, ICAI has added it while calculating purchase consideration.
QUESTION 42:
MTP M 16
Teer Ltd. is considering acquisition of Nishana Ltd. CFO of Teer Ltd. is of opinion that Nishana Ltd. will
be able to generate operating cash flows (after deducting necessary capital expenditure) of ₹ 10 crore
per annum for 5 years
The following additional information was not considered in the above estimations.
a. Office premises of Nishana Ltd. can be disposed of and its staff can be relocated in Teer Ltd.’s
office not impacting the operating cash flows of either businesses. However, this action will
generate an immediate capital gain of ₹ 20 crore.
b. Synergy Gain of ₹ 2 crore per annum is expected to be accrued from the proposed acquisition.
c. Nishana Ltd. has outstanding Debentures having a market value of ₹ 15 crore. It has no other
debts.
d. It is also estimated that after 5 years if necessary, Nishana Ltd. can also be disposed of for an
amount equal to five times its operating annual cash flow.
Calculate the maximum price to be paid for Nishana Ltd. if cost of capital of Teer Ltd. is 20%. Ignore
any type of taxation.
Solution:
Calculation of Maximum Price:
Year 0 1 2 3 4 5
Operating cash flow 10 10 10 10 10
Gain on Sale of office premise 20
Synergy Benefits 2 2 2 2 2
Disposal of Nishana Ltd. 50
Net cash flow 20 12 12 12 12 62
PVF @ 20% 1 0.833 0.694 0.579 0.482 0.402
Present value 20 9.996 8.328 6.948 5.784 24.924
45
Adish Jain CA CFA
Total of Present value 75.984

Less: Market Value of Debentures -15.000
60.984
Thus, the maximum price to be paid for acquisition of Nishana Ltd. ₹ 60.984 crore.
QUESTION 43:
M 12
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 ₹ 3,60,000
per annum in three year's time which will continue for ever. This investment is possible if dividend is
reduced for next two years
Whether the company should accept the project? Also analyse the effect on the market price of the
share, if the company decides to accept the project.
Solution:
19,20,000
Calculation of Ke = = 16%
12,00,000 × 10
Calculation of NPV of the Project:
Year CFs PVF @ 16% DCFs
1 -8,00,000 0.862 -6,89,600
2 -8,00,000 0.743 -5,94,400
3,60,000
2 = 22,50,000 0.743 16,71,750
0.16
3,87,750
As NPV of the project is positive, the value of the firm will increase by ₹ 3,87,750.
The market price per share will increase from ₹ 10 to:
3,87,750
= 10 +
12,00,000
= ₹ 10.32
Solution by ICAI:
Year CFs PVF @ 16% DCFs
1 -8,00,000 0.862 -6,89,600
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Adish Jain CA CFA
2 -8,00,000 0.743 -5,94,400

3,60,000
3 = 22,50,000 0.641 14,41,480
0.16
1,57,295
As NPV of the project is positive, the value of the firm will increase by ₹ 1,57,295. The market price
per share will increase by 13 paisa.
QUESTION 44:
MTP M 17
MS Stones has different divisions of home interiors products. Recently, due to economic slowdown,
the Managing Director of the Company expressed it desire to divestiture its ceramic tile business.
The relevant financial details of this business are as follows:
Estimated Pre-Tax Cash Flow Next Year = ₹ 200 Crore
Book Value of Liabilities = ₹ 780 Crore
In an order to increase its share in the ceramic tile market, the Tripati Tiles Ltd. showed its interest
in the acquisition of this unit and offered a proceed of ₹ 950 Crore for the same to MS Stones.
The other data pertaining to the business are as follows:
Tax Rate 30%
Growth Rate 4%
Applicable Discount Rate for Tile Business 12%
If market value of liabilities are ₹ 40 Crore more than book value, you are required to advice MD
whether she should go for divestiture of the tile business or not.
Solution:
200 crore (1-0.30)
PV of Cash Inflows: =
0.12-0.04
= ₹ 1750 Crore
Market Value of Liabilities = 780 Crore + 40 Crore
= 820 Crore
Net Equity Value = 1750 Crore – 820 Crore
= 930 Crore
Since, the Tripati Tiles is offering ₹ 950 Crore, more than value of equity of ₹ 930 Crore, the company
should go further with decision of divesture of tile business.
QUESTION 45:
N 18 | M 16 | N 11 | M 07 | RTP | SM
47
Adish Jain CA CFA
ABC Co. is considering a new sales strategy that will be valid for the next 4 years. They want to know
the value of the new strategy. Following information relating to the year which has just ended, is
available:
Income Statement ₹
Sales 20,000
Gross margin (20%) 4,000
Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Tax (30%) 600
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Current Assets 4,000
Equity 12,000
If it adopts the new strategy, sales will grow at the rate of 20% per year for three years From 4th year
onward Cash Flow will be stabilized. The gross margin ratio, Assets turnover ratio, the Capital
structure and the income tax rate will remain unchanged.
Depreciation would be at 10% of net fixed assets at the beginning of the year.
The Company’s target rate of return is 15%.
Determine the incremental value due to adoption of the strategy.
Solution:
Value of the company before new strategy
Self-note: Since, asset turnover ratio has to remain same, therefore, value of fixed assets has to
be maintained. Capex to buy new assets will be same as the amount of depreciation on previous
year’s asset and hence they will offset each other.
PAT or FCFE = 1,400
1,400
Value of company Before strategy = = 9,333.33
0.15
Value of company after the strategy
Value of Fixed Assets:
Opening Depreciation Closing Capex
Years
(a) (b) (c) (c + b – a)
1 8,000 800 8000 + 20% = 9,600 2,400
2 9,600 960 11,520 2,880
3 11,520 1,152 13,824 3,456
4 13,824.0 1,382.4 13,824.0 1,382.4
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Adish Jain CA CFA
Calculation of increase in working capital:

Year WC = CA - CL Increase in WC
0 4,000
1 4,800 800
2 5,760 960
3 6,912 1,152
4 6,912 0
Calculation of CFAT:
Year 1 2 3 4
Sales at 20% growth 24,000 28,800 34,560.0 34,560.0
PAT @ 7% of sales 1,680 2,016 2,419.2 2,419.2
Add: Dep 800 960 1,152.0 1,382.4
Less: Capex -2,400 -2,880 -3,456.0 -1,382.4
Less: Increase in WC -800 -960 -1,152.0 0.0
-720 -864 -1,036.8 2,419.2
Calculation of value of company:
Years CFS / TV PVF @ 15% DFCs
1 -720 0.87 -626.4
2 -864 0.756 -653.18
3 -1036.8 0.658 -682.21
2419.2
3 = 16128.0 0.658 10612.22
0.15
8,650.43
Incremental Value due to adoption of strategy = 8650.43 – 9,333.33
= - 682.90
Conclusion: The strategy is not financially viable.
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Adish Jain CA CFA
D. Asset Based Valuation Models

QUESTION 46:
RTP N 11
Two Companies ABC Ltd and XYZ Ltd are in same industry. To increase its size, ABC Ltd made a
takeover bid for XYZ Ltd.
Equity Beta of ABC and XYZ is 1.20 and 1.05 respectively. Risk Free Rate is 10% and Market Rate of
Return is 16%. The growth rate of earnings after tax of ABC Ltd. in recent years has been 15% and
XYZ’s is 12%. Further both companies continuously followed Constant Dividend Policy. Mr. V, the CEO
of ABC requires information about how much Premium above the current Market Price to offer for
XYZ’s shares. Two suggestions have forwarded by Merchant Bankers –
1. Price based on XYZ’s Net worth as per Balance Sheet, after adjusting Current Value of Assets and
estimated after tax profit for the next 5 years
2. Price based on Dividend Valuation Model, using existing Growth Rate estimates.
Summarized Balance Sheet of Both Companies (₹ in Lakhs)
Liabilities ABC Ltd XYZ Ltd Assets ABC Ltd XYZ Ltd
Equity Share Capital 2,000 1,000 Land & Building 5,600 1,500
General Reserves 4,000 3,000 Plant & Machinery 7,200 2,800
Share Premium 4,200 2,200 Long Term Loans 5,200 1,000
Current Liabilities - Current Assets -
Sundry Creditors 2,000 1,100 Accounts Receivable 3,400 2,400
Bank Overdraft 300 100 Stock 3,000 2,100
Tax Payable 1,200 400 Bank/Cash 200 400
Dividend Payable 500 400 - -
Total 19,400 9,200 Total 19,400 9,200
Profit & Loss A/c (₹ in Lakhs)
Particulars ABC Ltd XYZ Ltd Particulars ABC Ltd XYZ Ltd
To Net Interest 1,200 220 By Net Profit 7,000 2,550
To Taxation 2,030 820
To Distributable Profit 3,770 1,510 - -
Total 7,000 2,550 Total 7,000 2,550
To Dividend 1,130 760 By Distributable Profit 3,770 1,510
To Balance c/d 2,640 750 - -
Total 3,770 1,510 Total 3,770 1,510
Additional Information:
1. ABC Ltd.’s Land & Building have been recently revalued. XYZ Ltd’s have not been revalued for 4
years, and during this period the average value of Land & Building have increased by 25% p.a.
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Adish Jain CA CFA
2. The Face Value of Share of ABC Ltd is ₹ 10 and of XYZ Ltd is ₹ 25 per share.
3. The current market Price of Shares of ABC Ltd is ₹ 310 and of XYZ Ltd’s ₹ 470 per Share.
From the above data, you are required to calculate the Premium per Share above XYZ’s Current Share
Price by two suggested valuation methods. Discuss which of these two values should be used for
bidding the XYZ’s Shares clearly stating the assumptions made.
Solution:
Self-note: There is a mistake in the question as the balance sheet totals don’t match. This is because
of term loan, which is supposed to be a liability.
a) Net Asset Value Model:
Calculation of net worth:
Particulars ₹ Lakhs
Asset
Land & Building [1500  (1.25)4] 3662.11
Plant & Machinery 2800
Account Receivable 2400
Stock 2100
Bank / Cash 400 11362.11
Liabilities
Long term loan -1,000
Sundry Creditors -1,100
Bank Overdraft -100
Tax Payable -400
Dividend Payable -400 -3,000
Net Asset Value 8362.11
Calculation of after-tax Profit for 5 years
Year CF’s
1 1,691.20
2 1,894.14
3 2,121.44
4 2,376.01
5 2,661.13
10,743.74
Value of the company XYZ = Net worth + After Tax Profits
= 8362.109 + 10743.935
= 19106.04 lac
51
Adish Jain CA CFA
19106.04
Value per share of XYZ: =
40
= 477.65
Premium per share = 477.65 – 470 = ₹ 7.65
Or
7.65
= = 1.63%
470
This is not a sound basis for valuation as it ignores the time value of money. The premium of
1.63% above the current market price is very small compared to those achieved in many real
bids.
(2) Dividend Valuation Model:
Dividend Total 760
 No. of shares 40
Dividend 19 per shares
Ke using CAPM = Rf +βj (Rm - Rf)
=10% + 1.05(16% - 10%)
= 16.3%
D1
P0 =
Ke  g
19  1.12
=
0.163  0.12
= 494.88
Premium per share = 494.88 – 470 = 24.88
Or
24.88
= = 5.29%
470
Discussion: Value of ₹ 494.88 arrived using dividend valuation model should be used for bidding
because it is more logical method of arriving at the value of share.
Assumption:
 Valuation is based on a constant growth rate and unchanged dividend policy.
 It will be more rational to assess the value of XYZ Ltd. incorporating post merger synergies.
QUESTION 47:
N 20
52
Adish Jain CA CFA
ICL is proposing to take over SVL with-an objective to diversify. ICL's profit after tax (PAT) has grown
@ 18 per cent per annum and SVL's PAT is grown @ 15 per cent per annum. Both the companies pay
dividend -regularly. The summarised Profit & Loss Account of both the companies are as follows:
in crores
Particulars ICL SVL
Net Sales 4,545 1,500
PBIT 2,980 720
Interest 750 25
Provision for Tax 1,440 445
PAT 790 250
Dividends 235 125
Particulars ICL SVL

Fixed Assets
Land & Building (Net) 720 190
Plant & Machinery (Net) 900 350
Furniture & Fixtures (Net) 30 1650 10 550
Current Assets 775 580
Less Current Liabilities
Creditors 230 130
Overdrafts 35 10
Provision for Tax 145 50
Provision for dividends 60 470 50 240
Net Assets 1955 890
Paid up Share Capital (₹ 10 per share) 250 125
Reserves and Surplus 1,050 1,300 660 785
Borrowing 655 105
Capital Employed 1,955 890
Market Price Share (₹) 52 75

ICL's Land & Buildings are stated at current prices. SVL's Land & Buildings are revalued three years
ago. There has been an increase of 30 per cent per year in the value of Land & Buildings.
SVL is expected to grow @ 18 per cent each year, after merger.
ICL’s Management wants to determine the premium on the shares over the current market price
which can be paid on the acquisition of SVL.
You are required to determine the premium using:
53
Adish Jain CA CFA
a. Net Worth adjusted for the current Value of Land & Buildings plus the estimated average profit
after tax (PAT) for the next five years
b. The dividend growth formula.
c. ICL will push forward which method during the course of negotiations?
Period 1 2 3 4 5
FVIF (30%, t) 1.3000 1.6900 2.1970 2.8560 3.7130
FVIF (15%, t) 1.1500 2.4725 3.9938 5.7424 7.7537
Solution:
1) Net Worth Method
Calculation of Net worth of SVL
(In ₹ crores)
Assets
L&B [190  2.1970] 417.43
P&M 350
F&F 10
CA 580 1357.43
Liabilities
Creditors 130
OD 10
PFT 50
PFD 50
Borrowings 105 345
Net worth 1012.43
Calculation of Estimated Average PAT:
Total profit on next 5 years = Current PAT  PVAF (15%, 5 years)
= 250  7.7537
= 1938.43
1938.43
Average profit for 1 year =
5
= 387.69
Total Value of the firm = 1012.43 + 387.69
= 1400.12
1400.12
Value of firm per share =
12.5
54
Adish Jain CA CFA
= 112.01
Or
37.01
= = 49.33%
75
2) Dividend Growth Formula
125
Dividend per share = = ₹ 10
12.5
Pre merger Growth = 15%
10 × 1.15
Pre merger Ke = + 15%
75
= 30.33%
Expected growth after merger = 18%
10  1.18
Value per share =
0.3033  0.18
= 95.70
Or
20.70
= = 27.60%
75
c) ICL will put forward valuation based on growth rate method as it will lead to least cash outflow
55
Adish Jain CA CFA
E. Earnings Based Valuation Models

QUESTION 48:
M 08 | RTP
Given below is the Balance Sheet of S Ltd. as on 31.3.2008:
Liabilities ₹ (In lakh) Assets ₹ (In lakh)
Share Capital (share of ₹ 10) 100 Land and building 40
Reserves and surplus 40 Plant and machinery 80
Long Term Debts 30 Investment 10
Stock 20
Debtors 15
Cash at bank 5
170 170
You are required to work out the value of the Company’s shares on the basis of Net Assets method
and Profit-earning capacity (capitalization) method and arrive at the fair price of the shares, by
considering the following information:
a. Profit for the current year ₹ 64 lakhs includes ₹ 4 lakhs extraordinary income and ₹ 1 lakh income
from investments of surplus funds; such surplus funds are unlikely to recur.
b. In subsequent years, additional advertisement expenses of ₹ 5 lakhs are expected to be incurred
each year.
c. Market value of Land and Building Plant and Machinery have been ascertained at ₹ 96 lakhs and
₹ 100 lakhs respectively. This will entail additional depreciation of ₹ 6 lakhs each year.
d. Effective Income-tax rate is 30%.
e. The capitalization rate applicable to similar businesses is 15%.
Solution:
Value of share using NAV method:
Land & Building 96,00,000
Plant & machinery 1,00,00,000
Investment 10,00,000
Stock 20,00,000
Debtors 15,00,000
Cash & Bank 5,00,000
Less: Long term Debt -30,00,000
Net Assets 2,16,00,000
÷ No. of shares 10,00,000
Value Per Share 21.6
56
Adish Jain CA CFA
Value of share using Earning Capitalisation

Profit before tax 64,00,000
Less: Extra ordinary income -4,00,000
Income from Investments -1,00,000
Additional Expenditure -5,00,000
Depreciation -6,00,000
Future Maintainable PBT 48,00,000
Less: Tax Rate @ 30% -14,40,000
Future Maintainable PAT 33,60,000
÷ Capitalization rate 15%
Value of Firm 2,24,00,000
Value of equity = 2,24,00,000 – 30,00,000
=1,94,00,000
1,94,00,000
Value Per share = = 19.4
10,00,000
21.6  19.4
Fair Value per Share =
2
= 20.50 per share
Self-Note:
Assumptions made:
 Profit given is profit before tax
 The value arrived using earnings capitalisation method is value of business because capitalisation
rate given is business (Ko) & not of only equity (Ke).
QUESTION 49:
N 12
H Ltd. agrees to buy over the business of B Ltd. effective 1St April, 2012. The summarized Balance
Sheets of H Ltd. and B Ltd. as on 31st march 2012 are as follows:
Balance Sheet as at 31st March, 2012 (in Crores of Rupees)
Liabilities: H. Ltd. B. Ltd.
Paid up share Capital
- Equity Shares of ₹ 100 each 350.00
- Equity Shares of ₹ 10 each 6.50
Reserve & Surplus 950.00 25.00
Total 1,300.00 31.50
Assets:
57
Adish Jain CA CFA
Net Fixed Assets 220.00 0.50

Net Current Assets 1,020.00 29.00
Deferred Tax Assets 60.00 2.00
Total 1,300.00 31.50
H Ltd. proposes to buy out B Ltd. and the following information is provided to you as part of the
scheme of buying:
1. The weighted average post tax maintainable profits of H ltd. and B Ltd. for the last 4 years are ₹
300 crores and ₹ 10 crores respectively.
2. Both the companies envisage a capitalization rate of 8%.
3. H Ltd. has a contingent liability of ₹ 300 cores as on 31st March, 2012.
4. H Ltd. to issue shares of ₹ 100 each to the shareholders of B Ltd. in terms of the exchange ratio
as arrived on a Fair Value basis. (Please consider weights of 1 and 3 for the value of shares arrived
on Net Assets basis and Earnings capitalization method respectively for both H Ltd. and B Ltd.
You are required to arrive at the value of shares of both H Ltd. and B Ltd. under:
a. Net Asset Value Method
b. Earnings Capitalisation Method
c. Exchange ratio of shares of H Ltd. to be issued to the shareholders of B Ltd. on a Fair value basis
(taking into consideration the assumption mentioned in point 4 above.)
Solution:
(a) Net Asset Value Method
Particulars H Ltd. B Ltd.
Net Fixed Assets 220 0.5
Net Current Assets 1020 29
Deferred Tax Assets 60 2
Less: Contingent liabilities -300 0
Net Asset Value 1000 31.5
 Numberof Shares 3.5 0.65
Per share value 285.714 48.462
(b) Earning Capitalisation Method

H Ltd. B Ltd.
Future Maintainable Profit 300 10
÷ Capitalization rate 0.08 0.08
Value of Equity 3750 125
÷ Number of shares 3.5 0.65
Value per Share 1071.43 192.31
58
Adish Jain CA CFA
(c) Fair Value Per Share

H Ltd. B Ltd.
285 .714  1  1071 .43  3 48 .462  1  192 .31  3
4 4
875 156.348
 156.348 
For every share of B Ltd., H Ltd should issue:   = 0.1787 shares
 875 
QUESTION 50:
M 19
The closing price of LX Ltd. is ₹ 24 per share as on 31st March, 2019 on NSE Ltd. the Price Earnings
Ratio Was 6. It was found that an amount of ₹ 24 Lakhs as income and an extra ordinary loss of ₹ 9
lakhs were included in the books of accounts. The existing operations except for the extraordinary
items are expected to continue in future. Further the company has launched a new product during
the year with the following expectations:
(₹ in Lakhs)
Sales 150
Material Cost 40
Labour Cost 34
Fixed Cost 24
The company has 500,000 equity shares of ₹ 10 each and 100,000 9% Preference Shares of ₹ 100
each. The Price Earnings Ratio is 6 times. Post-tax cost of capital is 10 per cent per annum. Tax rate
is 34 per cent.
(i) Existing Profit from old operations
(ii) The value of business.
Solution:
Self-note: Question has missed to specify that income of ₹ 24 lakhs was extra-ordinary. However, it is
still assumed extraordinary from the flow of the question.
(i) Existing profit from old operations:
Particulars Amount
Market Price 24
÷PE Ratio 6
EPS 4
 Number of Shares 5,00,000
EAES 20,00,000
Add: Preference Dividend 9,00,000
59
Adish Jain CA CFA
PAT 29,00,000
(2) Value of Business
Existing PAT 29,00,000
 (1 - Tax rate)  66%
Existing PBT 43,93,939
Less: Extraordinary income -24,00,000
Add: Extra ordinary loss 9,00,000
28,93,939
Profit from new operation
Sales 1,50,00,000
Less: Material Cost -40,00,000
Labour Cost -34,00,000
Fixed Cost -24,00,000 52,00,000
Pre-tax future maintainable profits 80,93,939
Less: Tax @34% -27,51,939
Future Maintainable profit 53,42,000
53,42,000
Value of business =
0.10
= 5,34,20,000
QUESTION 51:
M 21 | N 16 | N 12 | M 09 | RTP
XN Ltd. reported a profit of ₹ 100.32 lakhs after 34% tax for the financial Year 2015- 2016. An analysis
of the accounts reveals that the income included extraordinary items of ₹ 14 lakhs and an
extraordinary loss of ₹ 5 lakhs. The existing operations, except for the extraordinary items, are
expected to continue in future. Further, a new product is launched and the expectations are as under:
₹
Sales 70
Material costs 20
Labour costs 16
Fixed Costs 10
The company has 50,00,000 Equity Shares of ₹ 10 each and 80,000, 9% Preference Shares of ₹ 100
each with P/E Ratio being 6 times.
(i) compute the value of the business. Assume cost of capital to be 12% (after tax) and
(ii) determine the market price per equity share.
60
Adish Jain CA CFA
Solution:
(i) Computation of value of business:
Existing PAT 1,00,32,000
 (1 - Tax rate)  66%
Existing PBT 1,52,00,000
Less: Extraordinary income - 14,00,000
Add: Extra ordinary loss 5,00,000
1,43,00,000
Profit from new operation
Sales 70,00,000
Less: Material Cost -20,00,000
Labour Cost -16,00,000
Fixed Cost -10,00,000 24,00,000
Pre-tax future maintainable profits 1,67,00,000
Less: Tax @ 34% -56,78,000
Future Maintainable profit 1,10,22,000
÷ Capitalization Rate 12%
Value of Business 9,18,50,000
(ii) Market Price per equity share
Particulars Amount
PAT 1,10,22,000
Less: Preference Dividend 7,20,000
EAES 1,03,02,000
÷ No of Shares 50,00,000
EPS 2.0604
PE Ratio 6
Market price per share 12.3624
QUESTION 52:
SM | RTP | MTP N 19
Capital Structure of Sun Ltd., as at 31.3.2003 was as under:
₹ in lakhs
Equity share capital 80
8% Preference share capital 40
12% Debentures 64
61
Adish Jain CA CFA
Reserves 32
Sun Ltd., earns a profit of ₹ 32 lakhs annual on an average before deduction of income-tax, which
works out to 35% and interest on debentures.
Normal return on equity shares of companies similarly placed is 9.6% provided.
1. Profit after tax covers fixed interest and fixed dividends at least 3 times.
2. Capital gearing ratio is 0.75.
3. Yield on share is calculated at 50% of profits distributed and at 5% on undistributed profits.
Sun Ltd., has been regularly paying equity dividend of 8%.
Compute the value per equity share of the company assuming the risk premium as:
a) 1% for every one time of difference for Interest and Fixed Dividend Coverage.
b) 2% for every one time of difference for Capital Gearing Ratio.
Solution:
Income Statement:
EBIT 32,00,000
Less: Int @ 12% (7,68,000)
PBT 24,32,000
Less: Tax @ 35% (8,51,200)
PAT 15,80,800
Less: PD @ 8% (3,20,000)
EAES 12,60,800
Less: Profit Dist. (Equity dividend) (6,40,000)
Undistributed Profit 6,20,800
Yield on share = 6,40,000  50% + 6,20,800  5%
= 3,51,040
PAT  Int on Debt
Interest & fixed Dividend coverage Ratio =
Int on Debt  Pr ef Div
15,80,800  7,68,000
=
7,68,000  3,20,000
= 2.16
Debt Pref
Capital gearing ratio =
ESHF
64,00,000 + 40,00,000
=
1,12,00,000
= 0.93
Calculating capitalisation rate:
Normal Rate of Return 9.6%
62
Adish Jain CA CFA
Adjustment for:
Add: Int & fixed Dividend coverage [(3 - 2.16) 1%] 0.84%
Add: Capital gearing Ratio [(0.93 - 0.75) 2%] 0.36%
Effective Capitalisation Rate 10.8%
Calculation of value per equity share
Yield
Value of Equity =
Capatalisa tion Rate
3,51,040
=
0.108
= ₹ 32,50,370
32,50,370
Per share value = = 40.63
80,000
QUESTION 53:
M 11
The following information is given for QB Ltd.
Earnings per share ₹ 12
Dividend per share ₹3
Cost of capital 18%
Internal Rate of Return on investment 22%
Retention Ratio 75%
Calculate the market price per share using
a. Gordon’s formula
b. Walter’s formula
Solution:
a. Gordon’s Formula:
( )
P0 =
₹ 12 (1 - 0.75)
=
0.18 - (0.75 × 0.22)
= ₹ 200
b. Walter Formula
r
D+ (E - D)
Ke
P0 =
Ke
63
Adish Jain CA CFA
0.22
3+ (12 - 3)
0.18
=
0.18
= ₹ 77.77
QUESTION 54:
N 20 | N 10 | M 06 | RTP
The following information relates to Maya Ltd:
Earnings of the company ₹ 10,00,000
Dividend payout ratio 60%
No. of Shares outstanding 2,00,000
Rate of return on investment 15%
Equity Capitalization rate 12%
a. What would be the market value per share as per Walter’s model?
b. What is the optimum dividend payout ratio according to Walter’s model and the market value
of company’s share at the payout ratio?
c. What inference could you draw?
Solution:
a) Market value per share as per Walter’s model
10,00,000
EPS = 5
2,00,000
10,00,000 60%
DPS = 3
2,00,000
r
D+ (E - D)
Ke
P0 =
Ke
0.15
3+ (5 - 3)
0.12
=
0.12
= 45.833
b) return on investment (15%) > equity capitalisation rate (12%)
 Optimal dividend payout ratio = 0%
Value of equity at zero payout ratio
0.15
0+ (5 - 0)
0.12
P0 =
0.12
64
Adish Jain CA CFA
= 52.0833
c) When, return on investment (15%) > equity capitalisation rate (12%), as the payout ratio
decreases, the value of share increases.
QUESTION 55:
M 17 | M 05
You are requested to find out the approximate dividend payment ratio as to have the Share Price at
₹ 56 by using Walter Model, based on following information available for a Company.
Particulars Amount (₹)
Net Profit 50 lakhs
Outstanding 10% Preference Shares 80 lakhs
Number of Equity Shares 5 lakhs
Return on Investment 15%
Cost of Capital (after Tax) (Ke) 12%
Solution:
Calculation of EPS:
EAT 50,00,000
Less: Preference Dividend (8,00,000)
EAES 42,00,000
 No. of shares 5,00,000
EPS 8.40
Calculating DPS (D) using Walter’s Model:
r
D+ (E - D)
Ke
P0 =
Ke
0.15
D0  8.4  D 
56 =
0.12
0.12
D =15.12
15.12
Dividend payout Ratio = = 180%
8.4
QUESTION 56:
M 07 | RTP
The following information is supplied to you:
65
Adish Jain CA CFA
₹
Total Earnings 2,00,000
No. of equity shares (of ₹ 100 each) 20,000
Dividend paid 1,50,000
Price/Earnings ratio 12.5
a. Ascertain whether the company is the following an optimal dividend policy.
b. Find out what should be the P/E ratio at which the dividend policy will have no effect on the
value of the share.
c. Will your decision change, if the P/E ratio is 8 instead of 12.5?
Solution:
a) Ke = 1/PE Ratio
= 1/12.5 = 8%
EAES
ROE =
ESHF
2,00,000
=
20,000 100
= 10%
 ROE (10%) > cost of equity (8%)
 Optimal payout ratio = 0 %
0.10
0+ (10 - 0)
0.08
Value at 0% payout =
0.08
= 156.25
b) For dividend policy to have no effect on the value of share, cost of equity = return on equity.
Hence, ke = r = 10%
1 1
Therefore, PE Ratio =   10 times
ke 10
c) When PE is = 8
Ke = 1/8 = 12.5
r = 10%
When, Ke > r
Payout ratio = 100 %
0.10
10 + (10 - 10)
0.125
Value of share at 100% payout =
0.125
66
Adish Jain CA CFA
= ₹ 80
QUESTION 57:
M 12
X Ltd. has an internal rate of return @ 20%. It has declared dividend @ 18% on its equity shares,
having face value of ₹ 10 each. The payout ratio is 36% and Price Earnings Ratio is 7.25. Find the cost
of equity according to Walter’s Model and hence determine the limiting value of its shares in case
the payout ratio is varied as per the said model.
Solution:
Internal Rate of Return (r) = 20%
Dividend (D) = 10  18% = 1.80
1.80
Earnings Per share (E) = =5
0.36
Price of share (P) = 5 x 7.25 = 36.25
r
D+ (E - D)
Ke
P0 =
Ke
0.20
1.80+ (5 - 1.80)
ke
36.25 =
ke
36.25 Ke2 = 1.80 Ke + 0.64
-36.25 Ke2 + 1.80 Ke + 0.64 = 0
Solving above equation for Ke
- b ± b2 - 4ac
Ke =
2a
-1.80 ± (1.80)2 - 4 × (-36.25) × 0.64

=
2 × (-36.25)
= 16%
Since, Internal rate of return (20%) > Cost of Equity (16%)
Therefore, 0% payout ratio will give limiting value of share
0.20
0+ (5 - 0)
0.16
P0 =
0.16
= ₹ 39.06
67
Adish Jain CA CFA
F. Relative Valuation
QUESTION 58:
N 21 MTP
Snake Ltd. is taking over Lizard Ltd, both are listed companies. The PE Ratio of Lizard Ltd. has been
low as 4 and high as 7 and is currently 5. Lizard Ltd.’s previous year EPS was ₹ 3.40 and current
expected EPS this year to be ₹ 4.00.
Determine the different range of values of shares using P/E Model.
Solution:
The range of values using P/E Ratio and EPS either historic or projected are as follows.
EPS Value (₹) P/E Ratio Value Value of
Shares
Historic 3.40 Lowest 4 13.60
Historic 3.40 Current 5 17.00
Historic 3.40 Highest 7 23.80
Expected 4.00 Lowest 4 16.00
Expected 4.00 Current 5 20.00
Expected 4.00 Highest 7 28.00
QUESTION 59:
J 21 | SM
On the basis of the following information:
Current dividend (Do) ₹2.50
Discount rate (k) 10.50%
Growth rate (g) 2%
a. Calculate the present value of stock of ABC Ltd.
b. Is its stock overvalued if stock price is ₹35, ROE = 9% and EPS = ₹2.25? Show detailed calculation.
Using PE Multiple Approach and Earning Growth Model.
Solution:
a) Present Value of the stock of ABC Ltd.:
2.50 × 1.02
V0 =
0.105 - 0.02
= ₹ 30
b) (i) Value of stock under the PE Multiple Approach
Particulars
Actual Stock Price ₹ 35.00
68
Adish Jain CA CFA
Return on equity 9%
EPS ₹ 2.25
PE Multiple (1/Return on Equity) = 1/9% 11.11
Market Price per Share ₹ 25.00
Since, Actual Stock Price is higher, hence it is overvalued.
(ii) Value of the Stock under the Earnings Growth Mode
Particulars
Actual Stock Price ₹ 35.00
Return on equity 9%
EPS ₹ 2.25
Growth Rate 2%
Market Price per Share [EPS ×(1+g)]/(Ke – g) = ₹ ₹ 32.79
2.25 × 1.02/0.07
Since, Actual Stock Price is higher, hence it is overvalued
QUESTION 60:
N 19
XY Ltd., a cement manufacturing company has hired you as a financial consultant of the company.
The Cement Industry has been very stable for some time and the cement companies SK Ltd. & AS
Ltd. are similar in size and have similar product market mix characteristic. Use comparable method
to value the equity of XY Ltd. In performing analysis, use the following ratios:
(i) Market to book value.
(ii) Market to replacement cost.
(iii) Market to sales
(iv) Market to Net Income
The following data are available for your analysis: (Amount in ₹)
SK Ltd. AS Ltd. XY Ltd.
Market Value 450 400 –
Book Value 400 300 250
Replacement Cost 600 550 500
Sales 550 450 500
Net Income 18 16 14
Solution:
Calculating average comparable ratios:
SK Ltd. AS Ltd. Average
Market to BV 450/400 = 1.125 400/300 = 1.333 [(1.125 + 1.333)/2] =1.229
69
Adish Jain CA CFA
Market to Replace Cost 450/600 = 0.75 400/550 = 0.727 0.739

Market to Sales 0.818 0.889 0.854
Market to Net Income 25 25 25
Calculating value of XY Ltd. using above ratios:
Particulars SK Ltd. AS Ltd. Average
Mkt to Book value 250 1.229 307.25
Mkt to Replacement Cost 500 0.739 369.5
Mkt to Sales 500 0.854 427
Mkt to Net Income 14 25 350
1453.75
1453 .75
Average value =
4
= 363.4375
QUESTION 61:
RTP N 18
T Ltd. recently made a profit of ₹ 50 crore and paid out ₹ 40 crore (slightly higher than the average
paid in the industry to which it pertains). The average PE ratio of this industry is 9. As per Balance
Sheet of T Ltd., the shareholder’s fund is ₹ 225 crore and number of shares is 10 crore. In case
company is liquidated, building would fetch ₹ 100 crore more than book value and stock would
realize ₹ 25 crore less. The other data for the industry is as follows:
Projected Dividend Growth 4%
Risk Free Rate of Return 6%
Average Dividend Yield 6%
The estimated beta of T Ltd. is 1.2. You are required to calculate value of T Ltd. using:
a. P/E Ratio
b. Dividend Yield
c. Valuation as per:
1. Dividend Growth Model
2. Book Value
3. Net Realizable Value
Solution:
(a) P/E Ratio = 9  ₹ 50 cr. = 450 cr.
40
(b) Dividend yield = = 666.67 cr.
6%
70
Adish Jain CA CFA
D1
(c) (1) Dividend growth model =
ke  g
40 crore × 1.04
=
0.12 - 0.04
= ₹ 520 crore
225
(2) Book value = ₹ 225 Cr. or = 22.5
10
(3) NRV = 225 + 100 – 25 = 300 cr.
QUESTION 62:
N 21
Strong Ltd., (SL), an all equity financed, conglomerate is in need to borrow ₹ 2,000 crore to finance
expansion of its core current operations. However, SL is susceptible to raise the amount from the
market. The CFO has suggested for divesting one of the two non prime units to reduce the overall
borrowings from the market. The following data, after internal due diligence, has been placed for
consideration of the Board:
(₹ Crores)
Particulars Unit 1 Unit 2
Reported Profit After Tax 147 140
Extra Ordinary Gains 16 8
Extra Ordinary Losses 20 12
Expected profit from the launch of new product 56 12
Price Earnings Ratio 10 12.5
Corporate Tax Rate (%) 30 30
You are required to advise the Board on the following:
a. The price at which the units can be divested,
b. The unit which can be divested so as to minimise the borrowings from the market and
c. The amount of borrowing.
Solution:
a) Price at which units can be Divested
(₹ Crore)
Particulars Unit I Unit II
Reported Profit after Tax 147 140
÷ (1 - Tax Rate) 70% 70%
Reported profit before Tax 210 200
Less: Extra Ordinary Gains 16 8
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Adish Jain CA CFA
Add: Extra Ordinary Losses 20 12

Add: Profit from New Product 56 12
Profit before Tax 270 216
Less: Tax @ 30% 81 64.80
Future Maintainable Profit after Tax 189 151.20
 PE Ratio 10 12.5
Price of Unit 1890 1890
b) Unit I can be divested as it has lower PE Ratio.
Self-note: Above answer is as per ICAI. Logically, we should divest Unit II because even for lower
earnings, it is being sold at a same value as Unit I.
c) The amount of borrowing ₹ 2000 crore – ₹ 1890 crore = ₹ 110 crore
QUESTION 63:
SM
The balance sheet of H K Ltd. is as follows:
₹ 000
Non-Current Assets 1000
Current Assets
Trade Receivables 500
Cash and cash equivalents 500
2000
Shareholders' funds 800

Long Term Debt 200
Current Liabilities and Provisions 1000
2000
The shares are actively traded and the Current Market Price (CMP) is ₹12 per share. Shareholder
funds represent 70,000 shares of ₹10 each and rest is retained earnings. Calculate the Enterprise
Value of HK Ltd.
Solution:
Calculation of enterprise value = Equity + Debt + Preference – Cash & Cash Equity
= 8,40,000+ 2,00,000 + 0 – 5,00,000
= 5,40,000
QUESTION 64:
SM
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Adish Jain CA CFA
A Ltd. made a Gross Profit of ₹10,00,000 and incurred Indirect Expenses of ₹4,00,000. The number
of issued Equity Shares is 1,00,000. The company has a Debt of ₹3,00,000 and Reserves & Surplus to
the tune of ₹5,00,000. The market related details are as follows:
Risk Free Rate of Return 4.50%
β of the Company 0.9
Determine:
a. Per Share Earning Value of the Company.
b. Equity Value of the company if applicable EBITDA multiple is 5.
Solution:
(a) Per Share Earning Value of the Company:
Ke = 4.5 + 0.9 (12 - 4.5) = 11.25%
Per share earning value of company (EPS)
Gross profit 10,00,000
Less: Indirect expense (4,00,000)
Net Profit EBITDA 6,00,000
÷ Ke 11.25%
Earnings Value of the company 53,33,333.33
 No. of shares 1,00,000
Earnings Value per share 53.33
(b) Equity Value of the company using EBITDA multiple
(₹)
EBITDA 600000
EBITDA Multiple 5
Capitalized Value 3000000
Less: Debt (300000)
Add: Surplus Funds 500000
Equity Value 3200000
QUESTION 65:
SM
There is a privately held company X Pvt Ltd that is operating into the retail space, and is now scouting
for angel investors. The details pertinent to valuing X Pvt Ltd are as follows:
The company has achieved break even this year and has an EBITDA of 90. The unleveraged beta based
on the industry in which it operates is 1.8, and the average debt to equity ratio is hovering at 40:60.
The rate of return provided by liquid bonds is 5%. The EV is to be taken at a multiple of 5 on EBITDA.
The accountant has informed that the EBITDA of 90 includes an extraordinary gain of 10 for the year,
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Adish Jain CA CFA
and a potential write off of preliminary sales promotion costs of 20 are still pending. The internal
assessment of rate of market return for the industry is 11%. The FCFs for the next 3 years are:
Year 1 2 3
Future Cash Flows 100 120 150
The pre-tax cost of debt will be 12%. Assume a tax regime of 30%.
What is the potential value to be placed on X Pvt Ltd?
Solution:
Value arrived using EBITDA multiple
EBITDA (Given) 90
Less: Extraordinary Gain -10
Less: Promotion Cost -20
Future Maintainable Profits 60
X EBITA multiple 5
Value of X Pvt. Ltd. 300
Value arrived using free Cash Flows:
E D1  t 
Unlevered Beta (βA) = E ×  d 
E  D1  t  E  D1  t 
0.60
1.8 = E × 0
0.60  0.401  0.30
e = 2.64
Calculating Ke = Rf +  (Rm – Rf)
= 5 + 2.64 (11-5)
= 20.844
60 40
Calculating KO = 0.2084 ×  0 .12 1  0 .30  
100 100
= 15.864%
Calculating Value:
Year CFs PVAF @ 15.864% DCFs
1 100 0.863 86.3
2 120 0.745 89.4
3 150 0.643 96.45
272.5
Potential value using EBITA multiple = 300
Potential value using free cash flow = 272.15
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Adish Jain CA CFA
300  272 .15

Average can be considered =
2
= 286.075
QUESTION 66:
N 11 | RTP
Using the chop-shop approach (or Break-up value approach), assign a value for Cranberry Ltd. whose
stock is currently trading at a total market price of €4 million. For Cranberry Ltd, the accounting data
set forth three business segments: consumer wholesale, retail and general centres. Data for the for
the firm’s three segments are as follows:
Business Segment Segment Sales Segment Assets Segment Income
Wholesale €225,000 €600,00 €75,000
Retail €720,000 €500,000 €150,000
General €2,500,000 €4,000,000 €700,000
Industry data for “Pure-play” firms have been complied and are summarized as follows:
Business Segment Capitalization/Sales Capitalization /Assets Capitalization/ Income
Wholesale 0.85 0.7 9
Retail 1.2 0.7 8
General 0.8 0.7 4
Solution:
Segment Sale Segment Assets Segment Income Total
Wholesale 1,91,250 4,20,000 6,75,000
Retail 8,64,000 3,50,000 12,00,000
General 20,00,000 28,00,000 28,00,000
30,55,250 35,70,000 46,75,000 1,13,00,250
1,13,00,250
Value of cranberry Ltd. = = 37,66,750
3
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Adish Jain CA CFA
G. Other Important Topics

QUESTION 67:
N 19
Following information is available of M/s. TS Ltd.
(₹ in crores)
PBIT 5.00
Less: Interest on Debt (10%) 1.00
PBT 4.00
Less: Tax @ 25% 1.00
PAT 3.00
No. of outstanding shares of ₹ 10 each 40 lakhs
EPS (₹) 7.5
Market price of share (₹) 75
P/E ratio 10 Times
TS Ltd. has an undistributed reserve of ₹ 8 crores. The company requires ₹ 3 crores for the purpose
of expansion which is expected to earn the same rate of return on capital employed as present.
However, if the debt to capital employed ratio is higher than 35%, then P/E ratio is expected to
decline to 8 Times and rise in the cost of additional debt to 14%. Given this data which of the following
options the company would prefer, and why?
Option (i): If the required amount is raised through debt, and
Option (ii): If the required amount is raised through equity and the new shares will be issue at a
price of ₹ 25 each.
Solution:
Interest Amount 1
Amount of Debt = = 10 crores
Interest rate (%) 10%
Equity share capital [40  10] 4 crores
Undistributed reserves 8 crores
Total Equity 12 crores
Total capital employed after fund raise = 12 + 10 + 3 = 25 Cr.
EBIT
Return on capital employed =
Debt  ESHF
5
= = 22.73%
10 + 12
Number of shares to be issued under option 2 = 3 Crores/25
= 0.12 Crores
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Adish Jain CA CFA
Particulars Option (i) Option (ii)

Total Debt (A) 10 + 3 = 13 Cr 10 Cr
Capital Employed (B) 25 25
Debt to CE Ratio (A/B) 52% 40%
Applicable PE Ratio 8 times 8 times
Cost of Additional debt 14% 14%
Calculating MP under both options:
Particulars Option (i) Option (ii)
EBIT [25  22.73%] 5.6825 5.6825
Int on Debt
 Existing  -1 -1
 Additional  3  14% = - 0.42 -
EBT 4.2625 4.6825
Less: tax @ 25% -1.0656 -1.1706
EAT 3.1969 3.5119
 Number of shares 0.40 0.40 + 0.12 = 0.52
EPS 7.99 6.75
PE Ratio 8 8
MP Per Share 63.92 54
Advice: Option 1 – raising money through debt, should be preferred as it leads to higher share price.
QUESTION 68:
N 20 | MTP M 23
The Balance Sheet of M/s. Sundry Ltd. as on 31-03-2020 is follows:
Liabilities ₹ In lakhs Assets ₹ In lakhs
Share Capital 300 Fixed Assets 600
Reserves 200 Inventory 500
Long Term Loan 400 Receivables 240
Short Term Loan 300 Cash 60
Payables & Provisions 200
Total 1400 Total 1400
Sales for the year was 600 lakhs. The sales are expected to grow by 20% during the year. The profit
margin and dividend pay-out ratio are expected to be 4% and 50% respectively.
The company further desires that during the current year Sales to Short Term Loan and Payables and
Provision should be in the ratio of 4:3. Ratio of fixed assets to Long Term Loans should be 1.5. Debt
Equity Ratio should not exceed 1.5.
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Adish Jain CA CFA

a. The amount of External Fund Requirement (EFR)
b. The amount to be raised from Short Term, Long Term and Equity funds.
Solution:
a) Amount of External Fund Requirement
In ₹
Capital invested in business (1400 – 200) 1200
Additional funds required 1200 x 20% (A) 240
Expected sales (₹ 600 + 20%) 720
Profit margin @ 4% 28.8
Dividend payout ratio @ 50% 14.4
Balance to be ploughed back (B) 14.4
Balance to be met from external source (A - B) 225.6
b) Amount to be raised from different sources:
1) Short term funds: Sales to short term loans and payables & provisions = 4:3
in ₹ lakhs
New amount of short term
loans & payables & provisions [600 x 3/4] 450
Less: Existing Amount 500
Amount to be raised 0
Self-note: Logically, sales of ₹ 600 + 20% = ₹ 720 should be considered for calculation.
However, ICAI, has considered only ₹ 600 Lakhs.
2) Long term funds: Ratio of fixed assets to long term loans = 1.5
in ₹ lakhs
New fixed assets [600 + 20%] 720
New long term loan [720/1.5] 480
Less: Existing loan term loan 400
Amount to be raised 80
3) Equity:
in ₹ lakhs
Amount to be raised from external sources 225.60
Less: Raised from short term 0
Existing loan term loan 80
Amount to be raised through equity 145.60
After raising funds as per above table, the debt to equity ratio will not exceed 1.5 times.
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Adish Jain CA CFA
QUESTION 69:
N 21
Following is the information of M/s. DY Ltd. for the year ending 31/03/2021:
Sales ₹ 1000 Lakh
Operating Expenses Including Interest ₹ 620 Lakh
8% Debentures ₹ 250 Lakh
Equity Share Capital (Face value of ₹ 10 each) ₹ 250 Lakh
Reserves and Surplus ₹ 250 Lakh
Market Value of DY Ltd ₹ 900 Lakh
Corporate Tax Rate 30%
Risk free Rate of Return 7%
Equity Beta 1.4
1. Calculate Weighted Average Cost of Capital of DY Ltd.
2. Calculate Economic Value Added
3. Calculate Market Value Added
Solution:
1. Weighted Average Cost of Capital of DY Ltd.
Cost of Equity (Ke) as per CAPM = Rf + β x (Rm – Rf)
= 7% + 1.4 x (12% - 7%)
= 14%
Cost of Debt (Kd) = 8% (1 – 0.30) = 5.60%
500 250
WACC (ko) = 14% × + 5.60% ×
750 750
= 11.20%
2. Economic Value Added (EVA) of DY Ltd.
Calculation of NOPAT:
₹ Lakhs
Sales 1000
Operating Expenses (excluding interest)
Operating Expense (incl. interest) 620
Less: Interest Expense - 20 600
EBIT 400
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Adish Jain CA CFA
Less: Tax @ 30% 120

Net Operating Profit after Tax (NOPAT) 280
Calculation of Capital Employed
₹ Lakhs
Equity Share Capital 250
Reserves & Surplus 250
8% Debentures 250
Total Capital Employed 750
EVA = NOPAT – (WACC × Total Capital)
= ₹ 280 Lakh – 0.1120 × ₹ 750 lakhs
= 196.00 lakhs
3. Determination of Market Value Added (MVA)
₹ Lakhs
Market value of DY Ltd. 900
Capital employed [₹ 250 Lakh + ₹ 250 Lakh + ₹ 250 Lakh] 750
Market Value Added 150
QUESTION 70:
M 11 | M 14 | N 10 | RTP
Delta Ltd.’s current financial year’s income statement reports its net income as ₹ 15,00,000. Delta’s
marginal tax rate is 40% and its interest expense for the year was ₹ 15,00,000. The company has ₹
1,00,00,000 of invested capital, of which 60% is debt. In addition, Delta Ltd. tries to maintain a
Weighted Average Cost of Capital (WACC) of 12.6%.
a. Compute the operating income or EBIT earned by Delta Ltd. in the current year.
b. What is Delta Ltd.’s Economic Value Added (EVA) for the current year?
c. Delta Ltd. has 2,50,000 equity shares outstanding. According to the EVA you computed in (ii), how
much can Delta pay in dividend per share before the value of the company would start to
decrease? If Delta does not pay any dividends, what would you expect to happen to the value of
the company?
Solution:
(a) Calculating operating income or EBIT
Net Income 15,00,000
÷ (1 – Tax Rate) 0.6
Profit before tax 25,00,000
+ Interest Paid 15,00,000
EBIT 40,00,000
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Adish Jain CA CFA
(b) EVA = NOPAT – Capital charge

= [40,00,000 (1 – 0.40)]– (1,00,00,000 × 12.6%)
= 11,40,000
11,40,000
(c) Delta can pay dividends = = 4.56
2,50,000
If Delta Ltd. does not pay a dividend, we would expect the value of the firm to increase
because it will achieve higher growth, hence a higher level of EBIT. If EBIT is higher, then all
else equal, the value of the firm will increase
QUESTION 71:
M 10 | RTP| SM
The following information is given for 3 companies that are identical except for their capital structure:
Orange Grape Apples
Total invested capital 1,00,000 1,00,000 1,00,000
Debt/assets ratio 0.8 0.5 0.2
Shares outstanding 6,100 8,300 10,000
Pre tax cost of debt 16% 13% 15%
Cost of equity 26% 22% 20%
Operating Income (EBIT) 25,000 25,000 25,000
The tax rate is uniform 35% in all cases.
a. Compute the Weighted average cost of capital for each company.
b. Compute the Economic Valued Added (EVA) for each company.
c. Based on the EVA, which company would be considered for best investment? Give reasons.
d. If the industry PE ratio is 11x, estimate the price for the share of each company.
e. Calculate the estimated market capitalisation for each of the Companies.
Solution:
a) Working for calculation of WACC
Orange Grape Apple
Total deb 80,000 50,000 20,000
Post tax Cost of debt 10.40% 8.45% 9.75%
Equity Fund 20,000 50,000 80,000
WACC
Orange: (10.4 x 0.8) + (26 x 0.2) = 13.52%
Grape: (8.45 x 0.5) + (22 x 0.5) = 15.225%
Apple: (9.75 x 0.2) + (20 x 0.8) = 17.95%
(b) Economic Value Added:
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Adish Jain CA CFA
Orange Grape Apple

WACC 13.52 15.225 17.95
EVA [EBIT (1-T) - (WACC x Invested Capital)] 2,730 1,025 -1,700
(c) Orange would be considered as the best investment since the EVA of the company is highest
and its weighted average cost of capital is the lowest
(d) Estimated Price of each company shares
Orange Grape Apple
EBIT (₹) 25,000 25,000 25,000
Less: Interest (₹) 12,800 6,500 3,000
Taxable Income (₹) 12,200 18,500 22,000
Less: Tax 35% (₹) 4,270 6,475 7,700
Net Income (₹) 7,930 12,025 14,300
÷ No. of Shares 6,100 8,300 10,000
EPS (₹) 1.30 1.45 1.43
Stock Price (EPS x PE Ratio) (₹) 14.30 15.95 15.73
Since the three entities have different capital structures they would be exposed to different
degrees of financial risk. The PE ratio should therefore be adjusted for the risk factor.
(e) Market Capitalisation
Estimated Stock Price (₹) 14.30 15.95 15.73
× No. of shares 6,100 8,300 10,000
Estimated Market Cap (₹) 87,230 1,32,385 1,57,300
QUESTION 72:
MTP N 20 | RTP
STR Ltd.’s current financial year's income statement reported its net income after tax as ₹50 Crore.
Following is the capital structure of STR Ltd. at the end of current financial year:
₹
Debt (Coupon rate = 11%) 80 Crore
Equity (Share Capital + Reserves & Surplus) 250 Crore
Invested Capital 330 Crore
Following data is given to estimate cost of equity capital:
Asset Beta of TSR Ltd. 1.11
Risk –free Rate of Return 8.5%
Average market risk premium 9%
The applicable corporate income tax rate is 30%.
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Adish Jain CA CFA
Estimate Economic Value Added (EVA) of RST Ltd. in ₹ lakh.

Solution:
Calculation of WACC
E
A = e 
E + D(1 - t)
250
1.11 = e 
250  80 1  0.30 
e = 1.359
Ke = Rf + β x (Rm – Rf)
= 8.5 + 1.359 (9)
= 20.74%
250 80
WACC = 20.74%  + 11% (1 - 0.3) 
330 330
= 17.58%
Calculation of NOPAT
PAT 50 crores
÷ (1 – Tax rate) 70%
PBT 71.43
Add: Interest 8.8
EBIT 80.23
Less: Tax Rate @ 30% 24.07
NOPAT 56.16
Calculation of EVA = NOPAT – Capital Employed  WACC
= 56.16 – 330  17.58%
= - 1.854 Cr.
QUESTION 73:
N 12 | N 04
With the help of the following information of Jatayu Limited compute the Economic Value Added:
Capital Structure Equity capital ₹ 160 Lakhs
Reserves and Surplus ₹ 140 lakhs
10% Debentures ₹ 400 Lakhs
Cost of Equity 14%
Financial Leverage 1.5 times
Income Tax Rate 30%
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Adish Jain CA CFA
Solution:
Calculation of EBIT
EBIT
Financial Leverage =
EBITInt
EBIT
1.5 =
EBIT 40
EBIT = 120
Calculation of Ko = Ke  We + Kd  Wd
300
= 0.14  + 0.10  (1 – 0.3)  400
700 700
= 10%
EVA = [120 (1 - 0.30)] - (700  10%)
= 14 Lakhs
QUESTION 74:
N 21
Fragrance Ltd. has reported a Net Operating Profit after Tax (NOPAT) to Capital Employed as 2.5%
plus Weighted Average Cost of Capital (WACC) for the year 31st March 2021. Economic Value added
is 4 Crores as on 31st March 2021.
You are required to calculate:
a. The amount of Capital Employed
b. NOPAT, if WACC is 10%
Solution:
(a) EVA = NOPAT – WACC × Capital Employed
₹ 4 Crore = (WACC + 0.025) × Capital Employed – WACC × Capital Employed
₹ 4 Crore = Capital Employed × 0.025
Capital Employed = Rs 160 Crore
(b) NOPAT if WACC is 10%
₹ 4 Crore = NOPAT – 0.10 × ₹ 160 core
NOPAT = ₹ 20 crore
QUESTION 75:
M 18
Constant Engineering Ltd. has developed a high tech product which has reduced the Carbon emission
from the burning of the fossil fuel. The product is in high demand. The product has been patented
and has a market value of ₹ 100 crore, which is not recorded in the books. The Net Worth (NW) of
Constant Engineering Ltd. is ₹ 200 Crore. Long term debt is ₹ 400 Crore. The product generates a
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Adish Jain CA CFA
revenue of ₹ 84 Crore. The rate on 365 days Government bond is 10 percent per annum. Bond
portfolio generates a return of 12 percent per annum. The stock of the company moves in tandem
with the market. Calculate Economic Value added of the company.
Solution:
Capital Employed:
Amount (₹ Crore)
Net Worth 200
Long Term Debts 400
Patent Rights 100
Total 700
400 300
WACC = × 10% + × 12%
700 700
= 10.85%
EVA = NOPAT – Capital Charge
= 84 crores – 700 crores × 10.85%
= 8.05 cr.
QUESTION 76:
N 20 | M 18 | RTP
Herbal World is a small, but profitable producer of beauty cosmetics using the plant Aloe Vera.
Though it is not a high-tech business, yet Herbal's earnings have averaged around ₹ 18.5 lakh after
tax, mainly on the strength of its patented beauty cream to remove the pimples.
The patent has nine years to run, and Herbal has been offered ₹ 50 lakhs for the patent rights.
Herbal's assets include ₹ 50 lakhs of property, plant and equipment and ₹ 25 lakhs of working capital.
However, the patent is not shown in the books of Herbal World. Assuming Herbal's cost of capital
being 14 percent, calculate its Economic Value Added (EVA).
Solution:
Capital Employed:
Amount (₹ in Lakhs)
Working Capital 25
Property, Plant & Equipment 50
Patent Rights 50
Total 125
= 18.5 – (125 × 14%)
= 1 lakh
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Adish Jain CA CFA
QUESTION 77:
M 19 | SM
Compute EVA of A Ltd. with the following information:
All figures in ₹ Lacs
Profit and Loss Statement Balance Sheet
Revenue 1000 PPE 1000
Direct Costs -390 Current Assets 300
Selling, General & Admin. Exp. (SGA) -200 1300
EBIT 410 Equity 700
Interest -10 Reserves 100
EBT 400 Non-Current Borrowings 100
Tax Expense -120 Current Liabilities & Provisions 400
EAT 280 1300
Assume Bad Debts provision of ₹ 20 Lac is included in the SGA, and same amount is reduced from
the trade receivables in current assets.
Also assume that the pre-tax Cost of Debt is 12%, Tax Rate is 30% and Cost of Equity (i.e.
shareholder’s expected return) is 8.45%.
Solution:
Calculation of NOPAT:
NOPAT
EBIT 410
Less: Taxes @ 30% -123
Add: Non-Cash Expenses 20
NOPAT 307
Self-note: Logically this amount of ₹ 20 lacs should be added to EBIT and after that tax should be
calculated on ₹ 410 + ₹ 20 = ₹ 430. However, ICAI has provided this solution
Invested Capital / Capital Employed:
Equity 700
Reserves 100 + 20 120
Non-current borrowings 100
920
Calculation of Ko:
Ko = 8.45  800/900 + 12(1 - 0.30)  100/900
= 8.44%
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Adish Jain CA CFA
Self-note: Logically We should be (820/920) and Wd (100/920). However, they wave not considered
effect of 20 lacs in calculation of WACC.
EVA = NOPAT - Invested Capital * WACC
= 307 - 920 * 8.44%
= 229.35
QUESTION 78:
RTP M 15
ABC Ltd. has divisions A, B & C. The division C has recently reported on annual operating profit of ₹
20,20,00,000. This figure arrived at after charging ₹ 3 crores full cost of advertisement expenditure
for launching a new product. The benefits of this expenditure is expected to be lasted for 3 years
The cost of capital of division C is ₹11% and cost of debt is 8%.
The Net Assets (Invested Capital) of Division C as per latest Balance Sheet is ₹ 60 crore, but
replacement cost of these assets is estimated at ₹84 crore.
You are required to compute EVA of the Division C.
Solution:
First necessary adjustment of the data as reported by historical accounting system shall be made as
follows:
₹
Operating Profit 20,20,00,000
Add: Cost of unutilized Advertisement Expenditures 2,00,00,000
22,20,00,000
Invested Capital (as per replacement cost) = ₹ 84 crore.
= 22,20,00,000 – (84,00,00,000 crore × 11%)
= ₹ 12,96.00,000
Self-note: The advertisement expenditure of ₹ 2 crores will be added in NOPAT but not in capital
employed because market value is given, therefore, everything is already included.
QUESTION 79:
RTP N 10
From the following data, compute the value of business using EVA method.
Current Period Projected Periods
2010 2011 2012
Total Invested Capital ₹ 90,00,000 ₹ 1,00,00,000 ₹ 1,10,00,000
Adjusted NOPAT ₹ 12,60,000 ₹ 14,00,000 ₹ 16,00,000
WACC 8.42%
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Adish Jain CA CFA
Capital Growth (g) is projected = 6.5% per year after 2012.

Solution:
Calculation of EVA:
EVA = NOPAT – (Invested Capital x WACC)
EVA1 = ₹ 14,00,000 – (₹ 1,00,00,000 × 0.0842) = ₹ 5,58,000
EVA2 = ₹ 16,00,000 – (₹ 1,10,00,000 × 0.0842) = ₹ 6,73,800
Value of company using EVA:
5,58,000 6,73,800 6,73,800 × (1.065) 1
= 90,00,000 + 1 + 2 + ×
(1 + 0.0842) (1 + 0.0842) 0.0842 - 0.065 (1 + 0.0842)2
= ₹ 4,18,83,000
QUESTION 80:
RTP
The following data pertains to XYZ inc. Engaged in software consultancy business as on 31st December
2010
($Million)
Income from consultancy 935.00
EBIT 180.00
Less: Interest on Loan 18.00
EBT 162.00
Tax @ 35% 56.70
105.30
Balance Sheet
($ Million)
Equity Stock (10 million 100 Land and Building 200
Share @ $ 10 each) Computers & Software 295
Reserves & Surplus 325 Current Assets:
Loans 180 Debtors 150
Current Liabilities 180 Bank 100
Cash 40 290
785 785
With the above information and following assumption you are required to compute
(a) Economic Value Added
(b) Market value Added.
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Adish Jain CA CFA
Assuming that:
a. WACC is 12%
b. The share of company currently quoted at $ 50 each.
Solution:
(i) EVA = NOPAT – capital charge
= 117 – [605 × 12%]
= $ 44.4 million
Total Capital Employed (in Millions)
Equity 100
Reserve and Surplus 325
Loans 180
Capital Employed $605
(ii) Market value added
Market Value of equity [10 × 50] $ 500 million
Book Value of Debt $ 425 million
MVA $ 75 million
QUESTION 81:
N 18 | N 04 | SM | RTP
ABC Limited’s shares are currently selling at ₹ 13 per share. There are 10,00,000 shares outstanding.
The firm is planning to raise ₹ 20 lakhs to Finance a new project.
Required:
What is the ex-right price of shares and the value of a right, if
a. The firm offers one right share for every two shares held.
b. The firm offers one right share for every four shares held.
c. How does the shareholders’ wealth (holding 100 shares) change from (i) to (ii)? How does right
issue increases shareholders’ wealth?
Solution:
P0 × n0 + P1 × n1
(a) Ex – right price =
n0 + n1
= 13  10 ,00 ,000  20 ,00 ,000
15 ,00 ,000
= 10
1
Number of Shares = 10,00,000 ×
2
= 500,000 shares
89
Adish Jain CA CFA
20,00,000
Issue Price = =₹4
5,00,000
Value of a Right = Ex-right price – issue price
= 10 – 4
=6
10 - 4
Value of Right per share =
2
= 3 per share
1310,00,000 20,00,000
(b) Ex-Right price =
12,50,000
= 12
1
Number of shares = 10,00,000 ×
4
= 2,50,000 shares
20,00,000
Issue Price = =8
2,50,000
Value of a right = 12-8
=4
12 - 8
Value of right per share =
4
=₹1
c) Calculation of effect of right issue on wealth of Shareholder with 100 shares:
Wealth of shareholder before right issue:
Value of Shares [100 × 13] 1300
Wealth of shareholder when 1:2 right shares:
Value of shares [150 × 10] 1500
Less: Cash paid [50 × 4] (200)
1300
Wealth of shareholder when 1:4 right shares:
Value of shares [125 × 12] 1500
Less: Cash paid [25 × 8] (200)
1300
Thus, there will be no change in the wealth of shareholders from (i) and (ii).
90
Adish Jain CA CFA
QUESTION 82:
M 03 | N 10 | RTP M 21 | RTP N 09
Pragya Limited has issued 75,000 equity shares of ₹ 10 each. The current market price per share is ₹
24. The company has a plan to make a rights issue of one new equity share at a premium of 60% for
every four shares held.
a. Calculate the theoretical post-rights price per share;
b. Calculate the theoretical value of the right alone;
c. Show the effect of the rights issue on the wealth of a shareholder, who has 1,000 shares assuming
he sells the entire rights; and
d. Show the effect, if the same shareholder does not take any action and ignores the issue.
e. Suppose Mr. A, who is holding 100 shares in Pragya Ltd. is not interested in subscribing to the
right issue, then advice what should he do.
Solution:
P0 × n0 + P1 × n1
(a) Post Right share price =
n0 + n1
24  75,000  16  18 ,750
=
93,750
= 22.40
(b) Theoretical value of right alone
Post Right Share Price 22.4
Less: Issue Price [10 + 60%] (16)
6.4 Per share
(c) Effect on the wealth of a shareholder if he sells the rights
Pre-Rights wealth [1,000  24] 24,000
Post-Right wealth
Value of shares [1,000  22.4] 22,400
 1,000 
Cash received  4  6.4  1600 24,000
Effect on wealth NIL

There is no change in the wealth of the shareholder
(d) Effect on the wealth of a shareholder if he ignores the rights
Pre-Rights wealth [1,000  24] 24,000
Post-Right wealth
Value of shares [1,000  22.4] 22,400
91
Adish Jain CA CFA
Loss of wealth 1,600

(e) If Mr. A is not interested in subscribing to the right issue, he can renounce his right eligibility
@ ₹ 6.4 per right and can earn a gain of:
1
= 100   6.4 = ₹ 480
4
QUESTION 83:
M 21
Aggressive Ltd., is proposing to fund its expansion plan of ₹ 12 crore by making a rights issue. The
current market price (CMP) is ₹ 40. The Board is willing to offer a discount of 20% on the CMP for the
rights issue. The Board is also desirous that the fall in Ex-right price of the shares be restricted to 10%
of CMP.
a. The number of new equity shares to be offered for each rights held,
b. Theoretical value of right and
c. The total number of equity shares to be issued.
Solution:
a) Number of new equity shares to be offered for each rights held
Subscription Price = 40 × 0.80
= ₹ 32 per share
Ex Right Price to be restricted to = 40 × 0.90
= ₹ 36
Let’s assume pre-right number of shares to be 1 and Right’s Ratio to be ‘R’
40 × 1 + 32 × R
₹ 36 =
1+R
R =1
Thus, 1 equity share be offered for each share held.
b) Theoretical Value of right = ₹ 36 – ₹ 32 = ₹ 4
₹ 12 Crore
c) No. of equity share to be issued = = 37,50,000
₹ 32
QUESTION 84:
RTP N 10
Monopolo Ltd. has a paid-up ordinary share capital of ₹ 2,00,00,000 represented by 4,00,000 shares
of ₹ 50 each. Earnings after tax in the most recent year were ₹ 75,00,000 of which ₹ 25,00,000 was
distributed as dividend. The current price/earnings ratio of these shares, as normally reported in the
financial press, is 8.
92
Adish Jain CA CFA
The company is planning a major investment that will cost ₹ 2,02,50,000 and is expected to produce
additional after tax earnings over the foreseeable future at the rate of 15% on the amount invested.
It was proposed by CFO of company to raise necessary finance by a rights issue to the existing
shareholders at a price 25% below the current market price of the company’s shares.
1. You have been appointed as Financial Consultant of the Company and are required to calculate:
a. The Current Market Price of the Shares already in issue,
b. The price at which the Rights Issue will be made,
c. The number of new shares that will be issued,
d. The Price at which the Shares of the Entity should theoretically be quoted on completion of
the Rights Issue (i.e., the ‘Ex-Rights Price’), assuming no incidental costs and that the market
accepts the Entity’s forecast of incremental earnings.
2. It has been said that, provided the required amount of money is raised and that the market is
made aware of the earnings power of the new investment, the financial position of Existing
Shareholders should be the same whether or not they decide to subscribe for the Rights they are
offered.
You are required to illustrate that there will be no change in the existing Shareholder’s Wealth.
Solution:
Earnings
1) (a) EPS =
No. of shares
75,00,000
=
4,00,000
= 18.75
CMP = PE Ratio  EPS
= 8  18.75 = 150
(b) Right Issue Price = 150 – 25%
= 112.5
2,02,50,000
(c) Number of shares to be issued =
112.5
= 1,80,000
1
(d) Ke =  12.5%
8
Calculation of PV of cash proceeds from investment
= 2 ,02 ,50 ,000  15 %
0.125
= 2,43,00,000
93
Adish Jain CA CFA
150 400,000  2,43,00,000

Ex – Right Price =
5,80,000
= 145.34
2. Pre-right Wealth [4,00,000  150] 6,00,00,000
Post Right Wealth
(1) When right shares are subscribed:
Value of Share [580,000  145.34] 8,42,97,200
Less: Cash paid [180,000  112.50] (2,02,50,000)
Net wealth 6,40,47,200
(2) When rights are sold:
Value of Share [4,00,000  145.34] 5,81,36,000
Add: Cash received [180,000  (145.34 - 112.50)] 59,11,200
Net wealth 6,40,47,200
Whether a shareholder decides so subscribe the shares or not, this wealth will not change.
QUESTION 85:
RTP N 15
Telbel Ltd. is considering undertaking a major expansion an immediate cash outlay of ₹ 150 crore.
The Board of Director of company are expecting to generate an additional profit of ₹ 15.30 crore
after a period of one year. Further, it is expected that this additional profit shall grow at the rate of
4% for indefinite period in future.
Presently, Telbel Ltd. is completely equity financed and has 50 crore shares of ₹10 each. The current
market price of each share is ₹ 22.60 (cum dividend). The company has paid a dividend of ₹ 1.40 per
share in last year. For the last few years dividend is increasing at a compound rate of 6% p.a. and it
is expected to be continued in future also. This growth rate shall not be affected by expansion project
in any way.
Board of Directors are considering following ways of financing the possible expansion:
1. A right issue on ratio of 1:5 at price of ₹15 per share.
2. A public issue of shares.
In both cases the dividend shall become payable after one year.
You as a Financial Consultant required to:
(a) Determine whether it is worthwhile to undertake the project or not.
(b) Calculate ex-dividend market price of share if complete expansion is financed from the right
issue.
(c) Calculate the number of new equity shares to be issued and at what price assuming that new
shareholders do not suffer any loss after subscribing new shares.
94
Adish Jain CA CFA
(d) Calculate the total benefit from expansion to existing shareholders under each of two financing
option.
QUESTION 86:
M 21 | M 19 | N 10 | M 06 | RTP
Rahul Ltd. has surplus cash of ₹ 100 lakhs and wants to distribute 27% of it to the shareholder. The
company decides to buy back shares. The Finance Manager of the company estimates that its share
price after re-purchase is like to be 10% above the buyback price-if the buyback route is taken. The
number of shares outstanding at present is 10 lakhs and the current EPS is ₹ 3.
a. The price at which the shares can be re-purchased, if the market capitalization of the company
should ₹ 210 lakhs after buyback.
b. The number of shares that can be re-purchased, and
c. The impact of share-repurchase on the EPS, assuming that net income is the same.
Solution:
(a) Let the Buy Back price be = x
Buy Back Amount
No. of share bought back =
Buy Back Price
100 lacs × 27% 27 lacs
= =
x x
Post Buy back no. of shares = Pre buyback no. of shares – no. of shares bought back
27 lacs
= 10 lacs -
x
Post Buy Back MP = 1.1x
Market capitalization after buyback = MPS after buy back  No. shares after buy back
27 lacs
210 lacs = 1.1x  [ 10 lacs - ]
x
x = 21.79
27,00 ,000
(b) No. of shares to be repurchased = = 1,23,910
21.79
10,00,000 × 3
(c) Post Buy Back EPS =
10,00,000 - 1,23,910
= 3.42
EPS will increase from ₹ 3 to ₹ 3.42 due to buy back
QUESTION 87:
95
Adish Jain CA CFA
N 18
Eager Ltd has Market Capitalization of ₹ 1,500 Crores and the Current market Price of its Share is ₹
1,500. It made a PAT of ₹ 200 Crores and the Board is considering a proposal to buy back 20% of the
Shares at a premium of 10% to the current Market Price. It plans to fund this through a 16% Bank
Loan. You are required to calculate the Post Buy Back Earnings per Share (EPS). The Company’s
Corporate Tax Rate is 30%.
Solution:
BB Price = 1,500 + 10% = 1,650
1500 Crore
Number of shares = = 1 Cr.
1500
Number of shares to be bought back = 1 Crore x 0.20 = 20 Lakh
Post buy-back no. of shares = (1 Cr. – 20Lakhs) = 80,00,000
Amount required for Buyback of Shares = ₹ 1,650 x 20 Lakh = ₹ 330 Crore
Amount of Loan @ 16% = ₹ 330 Crore
Interest on loan: = 330 Crore x 16% = ₹ 52.8 Cr.
Particulars (in ₹ crores)
Pre buyback PAT 200
÷ (1 - Tax Rate) 0.7
Pre buyback PBT/EBIT 285.71
Less: Post buy back Interest on loan -52.8
Post buyback PBT 232.91
Less: Tax @ 30% -69.87
Post buyback PAT 163.04 cr.
÷ Post Buy no. of share 0.8
Post buyback price 203.79
QUESTION 88:
M 21
SM Limited has a market capitalization of ₹ 3,000 crore and the current earnings per share (EPS) is ₹
200 with a price earnings ratio (PER) of 15. The Board of directors is considering a proposal to buy
back 20% of the shares at a premium which can be supported by the financials of the company. The
Boards expects post buy back market price per share (MPS) of ₹ 3057. Post buy back PER will remain
same. The company proposes to fund the buy back by availing 8% bank loan since available resources
are committed for expansion plans.
Applicable income tax rate is 30%.
96
Adish Jain CA CFA

a. The interest amount which can be paid for availing the bank loan,
b. The loan amount to be raised and
c. The premium per share and percentage premium paid over the current MPS.
Solution:
Current Market Price of Share = ₹ 200 × 15 = ₹ 3,000
3,000 crore
No. of Shares = = 1 crore
3,000
No. of Shares proposed for Buyback = 20% of 1 crore = 20 Lakh
Post Buy back per share (₹) = ₹ 3,057
Pre & Post buyback PE Ratio = 15 times
3057
Post Buy back EPS = = ₹ 203.80
15
Post Buy back number of shares = 1 crore – 20 lakhs = 80 lakhs
Post buyback EAT = ₹ 203.80  80 Lakh = ₹ 16,304 Lakh
16,304
Post buyback EBT = = ₹ 23,291.429 Lakh
(1 - 0.30)
Pre buyback PAT = ₹ 200  1 crore = 20,000 Lakh
20,000
Pre buyback PBT = = ₹ 28571.429 Lakh
(1 - 0.30)
Particulars
Pre buyback PBT ₹ 28571.429 Lakhs
Less: Post buyback PBT ₹ 23291.429 Lakhs
Interest which can be paid for availing bank loan ₹ 5,280.00 Lakhs
÷ Interest Rate 8%
Loan Amount raised ₹ 66,000 Lakhs
Therefore, Amount paid for Buy back of Share ₹ 66,000 Lakhs

÷ No. of Shares Bought back 20 Lakhs
Share Buyback price per share ₹ 3,300
Less: Current Market Price per share (₹ 200  15) ₹ 3,000
Premium (in ₹) ₹ 300
300
Premium (in %)  100 10%
3000
97
Adish Jain CA CFA
QUESTION 89:
M 23
High Growth Ltd. (HGL) was having an excellent growth over a number of years. The Board of
Directors is considering a proposal to reward its shareholders by buying back 20% shares at a
premium. The premium is to be paid by raising a loan from the Bank. The interest on loan is to be
serviced by internal accruals as supported by the financials of HGL. The company has a market
capitalization of ₹ 15,000 crore and the current Earnings Per Share (EPS) is ₹ 600 with a Price Earnings
Ratio (PER) of 25. The Board expects a post buy back Market Price per Share (MPS) of ₹ 10,000. The
PER, post buy back, will remain the same. The loan can be availed at an interest rate of 16 % p.a.
Applicable corporate tax rate is 30 %.
You are required to calculate
a) The interest amount which can be paid for availing the bank loan.
b) The loan amount to be raised.
c) Buy back premium per share.
Solution:
a) Pre BB Price = 600 × 25 = ₹ 15000
15,000 Cr.
Pre BB number of shares = = 1 crore
15,000
Pre BB PAT = 600 × 1 Cr. = 600 Crore
Number of shares to be bought back = 1 Cr. × 20% = 0.2 Crore

Post BB number of shares = 1 Cr. – 0.2 Cr. = 0.8 Crore
Post BB MPS = 10,000
MPS 10,000
Post BB EPS = = = 400
PE 25
Post BB PAT = 400 × 0.8 Cr. = 320 Cr.
Pre BB PAT = 600 Cr.

600 Cr.
Pre BB PBT = = 857.14 Cr.
(1 - 0.3)
Since, there is no interest Pre BB
Therefore, Pre BB PBT = Pre BB EBIT
& also, Pre BB EBIT = Post BB EBIT = 857.14 Cr.
Now, Post BB PAT = 320 Crore
98
Adish Jain CA CFA
320 Cr.
Post BB PBT = = 457.14 Crore
(1 - 0.3)
Interest that can be paid post BB = Post BB EBIT – Post BB PBT
= 857.14 Cr. - 457.14 Cr.
= 400 Cr.
Interest (₹) 400 Cr.

b) Loan amount will be = = = ₹ 2500 Crore.
Interest (%) 0.16
Total Loan 2500 Cr.

c) Buy back price = =
Shares BB 0.2 Cr.
= ₹ 12500 per share
Premium per share = BB price – Post BB MPS
= ₹ 12,500 – ₹ 10,000
= ₹ 2,500
Or
2500
= = 25%
10,000
Self-note: In the ‘C’ part of the question, the institute has calculated the buyback premium by
deducting post BB MPS (rather than pre BB MPS) from the BB Price.
QUESTION 90:
N 13 | M 18
Intel Ltd., promoted by a Trans National Company, is listed on the stock exchange. The value of the
floating stock is ₹ 45 crores. The Market Price per Share (MPS) is ₹ 150.
The capitalisation rate is 20 percent.
The promoters holding is to be restricted to 75 per cent as per the norms of listing requirement. The
Board of Directors have decided to fall in line to restrict the Promoters’ holding to 75 percent by
issuing Bonus Shares to minority shareholders while maintaining the same Price Earnings Ratio (P/E).
a. Bonus Ratio;
b. MPS after issue of Bonus Shares; and
c. Free float Market capitalisation after issue of Bonus Shares
Solution:
Self-note: Since the information regarding the promoters’ holding is missing in the question, above
solution is based on assumption of promoter’s holding as 80%.
a) Free Float market capitalization 45,00,00,000
99
Adish Jain CA CFA
÷ MPS per share 150

Free float number of shares 30,00,000
÷ Free float holding 20%
Total number of shares 1,50,00,000
 Promotor’s holding 80%
Promotor’s number of shares 1,20,00,000
Even after bonus, promotor’s no. of shares remains same as 120 lacs, but holding % to be
taken as 80%
120 lacs
Hence total shares after bonus = = 160 lacs
75%
Number of bonus shares to be issued to minority = 160 lacs – 150 lacs = 10 lacs
Bonus Ratio = 10 lacs for 30 lacs
= 1:3
b) Pre-Bonus Market Cap = 150 lacs shares  ₹ 150
= 2,25,00,00,000
Post Bonus Market Cap (same) = 2,25,00,00,000
Total no. of share after bonus = 1,60,00,00,000
2,25,00,00,000
Post Bonus MPS =
1,60,00,000
= 140.625
(iii) Free float M. Cap = 40,00,000  140.625
= 56,25,00,000
100
Adish Jain CA CFA

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Equity & Corporate Valuation

A. Dividend based Valuation Models

Price of Share 4.00 4.00

b) and c) Comment on valuation and course of action:

Calculation of DPS = 3  0.60 = 1.80

(b) Revised growth = RR  ROE

Price per share = ₹ 2.50 x 7 times

Therefore, Operating cost is 90%

Target Debt Equity Ratio (DER) 2:3 4:1

D1 – 5 2.5 2.991 7.48

a) Intrinsic value of shares:

1 20% 6 0.8333 5.00

a. Expected Market Price per Share

2007 15% 3.673 32.86% 1.207 0.593 0.716

9 16% 52.25 42% 21.95 0.244 5.36

Less: Cost of new investment 1,75,00,000

For 2nd year onwards:

Impact on Share Price:

1.20 1.44 1.73 2.07 2.49 2.49 (1.10) 1

B. Cash Flow Based Valuation Models

Step 3: Calculate Ke using CAPM

Depreciation per share ₹ 39

Less: Capital Expenditure (336) (403.2) (483.84) (580.61) –

Kd = 13  (1 - 0.30) = 9.1% = 12.86  (1 - 0.30) = 9%

16.9  1 9.1  1 = 14  3  9  2 = 12%

Calculation of Value of firm

Expenditure Revenue) CA required

Determination of Present Value of Cash Inflows

C. NPV Based Questions of Valuation

Less: Redemption Outflow now -60,00,000

Total of Present value 75.984

2 -8,00,000 0.743 -5,94,400

Calculation of increase in working capital:

D. Asset Based Valuation Models

Particulars ICL SVL

Market Price Share (₹) 52 75

E. Earnings Based Valuation Models

Value of share using Earning Capitalisation

Net Fixed Assets 220.00 0.50

(b) Earning Capitalisation Method

(c) Fair Value Per Share

-1.80 ± (1.80)2 - 4 × (-36.25) × 0.64

Market to Replace Cost 450/600 = 0.75 400/550 = 0.727 0.739

Add: Extra Ordinary Losses 20 12

Shareholders' funds 800

300  272 .15

G. Other Important Topics

Particulars Option (i) Option (ii)

You are required to determine:

Less: Tax @ 30% 120

(b) EVA = NOPAT – Capital charge

Orange Grape Apple

Estimate Economic Value Added (EVA) of RST Ltd. in ₹ lakh.

Capital Growth (g) is projected = 6.5% per year after 2012.

Effect on wealth NIL

Loss of wealth 1,600

150 400,000  2,43,00,000

You are required to calculate:

Therefore, Amount paid for Buy back of Share ₹ 66,000 Lakhs