Security Analysis and Valuation Blue Red Ink (1) - Watermark
Security Analysis and Valuation Blue Red Ink (1) - Watermark
Question 3
X Limited, just declared a dividend of ₹ 14.00 per share. Mr. B is planning to purchase the
share of X Limited, anticipating increase in growth rate from 8% to 9%, which will
continue for three years. He also expects the market price of this share to be ₹ 360.00 after
three years.
You are required to determine:
(i) the maximum amount Mr. B should pay for shares, if he requires a rate of return of 13%
per annum.
(ii) the maximum price Mr. B will be willing to pay for share, if he is of the opinion that the
9% growth can be maintained indefinitely and require 13% rate of return per annum.
(iii) the price of share at the end of three years, if 9% growth rate is achieved and assuming
other conditions remaining same as in (ii) 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
Question 4
Piyush Loonker and Associates presently pay a dividend of Re. 1.00 per share and has a
share price of ₹ 20.00.
(i) If this dividend were expected to grow at a rate of 12% per annum forever, what is the
firm’s expected or required return on equity using a dividend-discount model approach?
(ii) 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?
Question 5
ABC Ltd. has been maintaining a growth rate of 10 percent in dividends. The company has
paid dividend @ ₹3 per share. The rate of return on market portfolio is 12 percent and the
risk free rate of return in the market has been observed as 8 percent. The Beta co-efficient of
company’s share is 1.5.
You are required to calculate the expected rate of return on company’s shares as per CAPM
Question 12
SAM Ltd. has just paid a dividend of ₹ 2 per share and it is expected to grow @ 6% p.a. After
paying dividend, the Board declared to take up a project by retaining the next three annual
dividends. It is expected that this project is of same risk as the existing projects. The results of
this project will start coming from the 4th year onward from now. The dividends will then be ₹
2.50 per share and will grow @ 7% p.a.
An investor has 1,000 shares in SAM Ltd. and wants a receipt of atleast ₹ 2,000 p.a. from this
investment.
Show that the market value of the share is affected by the decision of the Board. Also show as
to 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%.
Question 13
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.
Question 14
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
Question 15
XYZ company has current earnings of ₹ 3 per share with 5,00,000 shares outstanding. The
company plans to issue 40,000, 7% convertible preference shares of ₹ 50 each at par. The
preference shares are convertible into 2 shares for each preference shares held. The equity
share has a current market price of ₹ 21 per share.
(i) What is preference share’s conversion value?
(ii) What is conversion premium?
(iii) Assuming that total earnings remain the same, calculate the effect of the issue on the
basic earning per share (a) before conversion (b) after conversion.
(iv) If profits after tax increases by ₹ 1 million what will be the basic EPS (a) before
conversion and (b) on a fully diluted basis?
Question 16
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 are the ex-right price of shares and the value of a right, if
(i) The firm offers one right share for every two shares held.
(ii) The firm offers one right share for every four shares held.
(iii) How does the shareholders’ wealth change from (i) to (ii)? How does right issue
increases shareholders’ wealth?
Question 17
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
price of ₹ 16 for every four share held.
You are required to:
(i) Calculate the theoretical post-rights price per share;
(ii) Calculate the theoretical value of the right alone;
Question18
The stock of the Soni plc is selling for £50 per common stock. The company then issues rights
to subscribe to one new share at £40 for each five rights held.
(a) What is the theoretical value of a right when the stock is selling rights-on?
(b) What is the theoretical value of one share of stock when it goes ex-rights?
(c) What is the theoretical value of a right when the stock sells ex-rights at £50?
(d) John Speculator has £1,000 at the time Soni plc goes ex-rights at £50 per common stock.
He feels that the price of the stock will rise to £60 by the time the rights expire. Compute his
return on his £1,000 if he (1) buys Soni plc stock at £50, or (2) buys the rights as the price
computed in part c, assuming his price expectations are valid.
Question 19
On the basis of the following information:
Current dividend (Do) = ₹ 2.50
Discount rate (k) = 10.5%
Growth rate (g) = 2%
(i) Calculate the present value of stock of ABC Ltd.
(ii) Is its stock overvalued if stock price is ₹ 35, ROE = 9% and EPS = ₹ 2.25? Show detailed
calculation.
Question 20
Given the following information:
Current Dividend ₹ 5.00
Discount Rate 10%
Growth rate 2%
(i) Calculate the present value of the stock.
(ii) Is the stock over valued if the price is ₹40, ROE = 8% and EPS = ₹ 3.00. Show your
calculations under the PE Multiple approach and Earnings Growth model.
Question 21
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
Reserves 32
Sun Ltd., earns a profit of ₹ 32 lakhs annually 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:
(a) Profit after tax covers fixed interest and fixed dividends at least 3 times.
(b) Capital gearing ratio is 0.75.
Question 22
Calculate the value of share from the following information:
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. 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.
ii.Value of Equity
Question 27
ABC (India) Ltd., a market leader in printing industry, is planning to diversify into defense
equipment businesses that have recently been partially opened up by the GOI for private
sector. In the meanwhile, the CEO of the company wants to get his company valued by a
leading consultants, as he is not satisfied with the current market price of his scrip.
He approached consultant with a request to take up valuation of his company with the
following data for the year ended 2009:
Share Price ₹ 66 per share
Outstanding debt 1934 lakh
Number of outstanding shares 75 lakh
Net income (PAT) 17.2 lakh
EBIT 245 lakh
Interest expenses 218.125 lakh
Capital expenditure 234.4 lakh
Depreciation 234.4 lakh
Working capital 44 lakh
Growth rate 8% (from 2010 to 2014)
Growth rate 6% (beyond 2014)
Free cash flow 240.336 lakh (year 2014 onwards)
The capital expenditure is expected to be equally offset by depreciation in future and the
debt is expected to decline by 30% in 2014.
Required:
Estimate the value of the company and ascertain whether the ruling market price is
undervalued as felt by the CEO based on the foregoing data. Assume that the cost of equity is
16%, and 30% of debt repayment is made in the year 2014.
Question 28
Personal Computer Division of Distress Ltd., a computer hardware manufacturing
company has started facing financial difficulties for the last 2 to 3 years. The management
of the division headed by Mr. Smith is interested in a buyout on 1 April 2013. However, to
make this buy-out successful there is an urgent need to attract substantial funds from
venture capitalists.
BONDS
Question 31
Nominal value of 10% bonds issued by a company is ₹100. The bonds are redeemable
at ₹ 110 at the end of year 5.Determine the value of the bond if required yield is (i) 5%, (ii)
5.1%,10% and (iv) 10.1%.
Question 32
Saranam Ltd. has issued convertible debentures with coupon rate 12%. Each debenture has
an option to convert to 20 equity shares at any time until the date of maturity. Debentures
will be redeemed at ₹ 100 on maturity of 5 years. An investor generally requires a rate of
return of 8% p.a. on a 5-year security. As an investor when will you exercise conversion for
given market prices of the equity share of (i) ₹ 4, (ii) ₹ 5 and (iii) ₹ 6.
Cumulative PV factor for 8% for 5 years : 3.993
PV factor for 8% for year 5 : 0.681
Question 33
An investors is considering the purchase of the following Bond:
Question 36
Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates
for valuing bonds:
Credit Rating Discount Rate
AAA 364 day T bill rate + 3% spread
AA AAA + 2% spread
A AAA + 3% spread
He is considering to invest in AA rated, ₹ 1,000 face value bond currently selling at ₹ 1,025.86.
The bond has five years to maturity and the coupon rate on the bond is 15% p.a. payable
annually. The next interest payment is due one year from today and the bond is redeemable at
par. (Assume the 364 day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invest in the
bond? Also calculate the current yield and the Yield to Maturity (YTM) of the bond.
Question 37
ABC Ltd. issued 9%, 5 year bonds of ₹ 1,000/- each having a maturity of 3 years. The present
rate of interest is 12% for one year tenure. It is expected that Forward rate of interest for one
year tenure is going to fall by 75 basis points and further by 50 basis points for every next
year in further for the same tenure. This bond has a beta value of 1.02 and is more popular in
the market due to less credit risk.
Calculate
(i) Intrinsic value of bond
(ii) Expected price of bond in the market.
Question 38
Calculate:
BY CA PRATIK JAGATI {7002630110, 9864047095}
Final kick
(i)If 10 years yield is 7.5% p.a. what price the Zero Coupon Bond would fetch on 31st
March, 2013?
(ii) What will be the annualized yield if the T-Bill is traded @ 98500?
(iii) If 10.71% GOI 2023 Bond having yield to maturity is 8%, what price would it fetch on
April 1, 2013 (after coupon payment on 31st March)?
(iv) If 10% GOI 2018 Bond having yield to maturity is 8%, what price would it fetch on April
1, 2013 (after coupon payment on 31st March)?
Question 39
(a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity.
Both the bonds have a face value of ₹ 1,000 and coupon rate of 8% (with annual interest
payments) and both are selling at par. Assume that the yields of both the bonds fall to 6%,
whether the price of bond will increase or decrease? What percentage of this
increase/decrease comes from a change in the present value of bond’s principal amount and
what percentage of this increase/decrease comes from a change in the present value of
bond’s interest payments?
(b) Consider a bond selling at its par value of ₹ 1,000, with 6 years to maturity and a 7%
coupon rate (with annual interest payment), what is bond’s duration?
(c) If the YTM of the bond in (b) above increases to 10%, how it affects the bond’s duration?
And why?
Question 40
John inherited the following securities on his uncle’s death:
ABC Ltd. has ₹ 300 million, 12 per cent bonds outstanding with six years remaining to
maturity. Since interest rates are falling, ABC Ltd. is contemplating of refunding these bonds
with a ₹ 300 million issue of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of
the new bond will be ₹ 6 million and the call premium is 4 per cent. ₹ 9 million being the
unamortized portion of issue cost of old bonds can be written off no sooner the old bonds are
called off. Marginal tax rate of ABC Ltd. is 30 per cent. You are required to analyse the bond
refunding decision.
Question 53
Pineapple Ltd has issued fully convertible 12 percent debentures of ₹ 5,000 face value,
convertible into 10 equity shares. The current market price of the debentures is ₹ 5,400. The
present market price of equity shares is ₹ 430.
Calculate:
(i) the conversion percentage premium, and
(ii) the conversion value
Question 54
GHI Ltd., AAA rated company has issued, fully convertible bonds on the following terms,
a year ago:
T 1 2 3
PVIF0.095, t 0.9132 0.8340 0.7617
Question 55
The following data is related to 8.5% Fully Convertible (into Equity shares) Debentures issued
by JAC Ltd. at ₹ 1000.
₹ In lakhs
12% term loan 300
Working capital borrowings:
From Bank at 15% 200
Public Deposit at 11% 100
The sales of the company are growing and to support this, the company proposes to obtain
additional borrowing of ₹ 100 lakhs expected to cost 16%.The increase in EBIT is expected to
be 15%.
Calculate the change in interest coverage ratio after the additional borrowing is effected and
comment on the arrangement made.
2. Net depreciated value of mortgage assets remains twice the amount of the mortgage
debt.
3. Debt-to-equity ratio remains below 0.50.
The HLL has net income after taxes of ₹ 2 crores and a 40% tax-rate, ₹ 40 crores in equity and
₹ 30 crores in depreciated assets, covered by the mortgage.
Assuming that 50% of the proceeds of a new issue would be added to the base of mortgaged
assets and that the company has no Sinking Fund payments until next year, how much more
10% debt could be sold under each of the three conditions? Which protective covenant is
binding?
Question 58
The following data is available for a bond:
Question 59
The following data are available for a bond
Bond X Bond Y
Face value ₹ 1,000 ₹ 1,000
Coupon 7% payable annually 8% payable annually
Years to maturity 1 4
Current price ₹ 972.73 ₹ 936.52
Current yield 10% 10%
Advice Mr. A whether he should invest all his money in one type of bond or he should buy
both the bonds and, if so, in which quantity? Assume that there will not be any call risk or
default risk.
Question 61
Mr. A is planning for making investment in bonds of one of the two companies X Ltd. and
Y Ltd. The detail of these bonds is as follows:
1st year 2nd year 3rd year 4th year 5th year
Another perspective on the term structure of interest rates is provided by the forward
interest rates, viz., the interest rates applicable to bonds in the future. Find forward rates
Question 71
M/s X Ltd. has paid a dividend of ₹ 2.5 per share on a face value of ₹ 10 in the financial year
ending on 31st March, 2009. The details are as follows:
Current market price of share ₹ 60
Growth rate of earnings and dividends10%
Beta of share 0.75
Average market return 15%
Risk free rate of return 9%
Calculate the intrinsic value of the share.
profits. Sun Ltd., has been regularly paying equity dividend of 8%.
Compute the value per equity share of the company.
Question 73
Rahim Enterprises is a manufacturer and exporter of woolen 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 Rs. 50 per share. The current issue price of this share is Rs. 125
ex-divided. Annual earning are Rs. 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 Rs. 1,75,00,000 in one year’s time and will produce annual cash
inflows thereafter of Rs. 50,00,000. Analyse the effect of the new project on dividend
payments and the share price
Question 74
A Ltd. has issued convertible bonds, which carries a coupon rate of 14%. Each bond is
convertible into 20 equity shares of the company A Ltd. The prevailing interest rate for
similar credit rating bond is 8%. The convertible bond has 5 years maturity. It is
redeemable at par at Rs. 100. The relevant present value table is as follows.
Present values t1 t2 t3 t4 t5
PVIF0.14, t 0.877 0.769 0.675 0.592 0.519
PVIF0.08, t 0.926 0.857 0.794 0.735 0.681
You are required to estimate:
(i) current market price of the bond, assuming it being equal to its fundamental value,
(ii) minimum market price of equity share at which bond holder should exercise
conversion option; and
(iii) duration of the bond.