Valuation Techniques in Financial Management

FINANCIAL MANAGEMENT

QUESTION 2
a) Price Earning Ratio
Price earning ration is ration used for valuing the company by measuring the current share
price of the stock in relation with net earnings per share. It is used by the investors to identify
whether company is generating enough returns in earnings. It also helps the organisation in
determining future direction of stock. Experts using the ration identify whether the stocks of
company are overvalued or undervalued (Aljifri and Ahmad, 2019). Earnings reflects about the
performance of company over the years. On the other P/E ratio speaks how well the company is
performing. P/E ratio refers to the price which investors is ready to pay for £1 earning or profits
of company.
P/E Ratio = Market Capitalisation /
Earnings after tax and preference
dividend
Market capitalisation = Market Price *
No. of shares
Market Price 2.05
No of shares 147
Market capitalisation = 301.35
Earnings after tax 40.4
Preference dividends = 0
Profit after tax & preference dividend = 40.4
P/E ratio 7.46
Market price = P/E * EPS
P/E 7.46
EPS = 40.4 / 147 = 0.2748
Market Price
(7.46 * 0.2748) 2.05
Alternatively
P/E = Market price / EPS 7.46
(2.05 / 0.2748)
b) Dividend Valuation Method
It is quantitative method for making predictions over the prices of company shares based
over theory which says current price of the share is equal to aggregate of all the future dividend
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payments on discounting to the present value. This method attempts at calculating the value of
share irrespective of the prevailing conditions of the market & considers dividend payout factor
& the expected market return. Where values of the share using DDM is more than currently
trading prices of shares then stock is said to be undervalued. Investors tend to buy such securities
as these stocks have higher growth opportunities. The method is also known as dividend discount
model by the investors (Stancu, Ion and et.al.,). The method is highly effective in valuing the
stocks of firm to determine whether the investors should purchase or sell the securities.
Return on Equity 11.6
Re = Rf + (Rm – Rf) * Beta
5 + (11 – 5 ) * 1.1
Dividend Valuation method
Price = D1 / (Ke – g)
D1 0.1326
(0.13 +(0.13*2%))
Ke 11.60%
g 2.00%
Price = D1 / (Ke – g) 1.38
(0.1326 / (0.116 – 0.02)
c) Discounting cash flow method
It is valuation method used for estimating value of the investments based over future cash
flows. DCF calculates the current value of the investment based over future projections over the
future cash flows from firm. The method is used by investors for financial investments and also
by business owners that are planning to do changes to the business like purchase of new
equipment. PV of the expected future inflows is arrived using a discounting rate for calculating
the discounted cash flows. Under this method when discounted cash flows are higher than
current investment cost, opportunity will be resulting in the positive returns. Discounting rate is
taken as weighted average COC for discounting the cash flows considering expected returns by
the shareholders.
Discounted cash flow method
WACC
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