Financial Management: Valuation Methods and Investment Appraisal Techniques

FINANCIAL
MANAGEMENT

TABLE OF CONTENTS
QUESTION 2.............................................................................................................................3
a)Price/earnings ratio.............................................................................................................3
b) Dividend valuation method................................................................................................3
c) Discounted cash flow method............................................................................................5
d) Critical review....................................................................................................................6
QUESTION 3.............................................................................................................................7
1. Calculation of different investment appraisal techniques..................................................7
2. Critical evaluation of benefits and limitation of different investment appraisal techniques
................................................................................................................................................9
REFERENCES.........................................................................................................................12

QUESTION 2
a)Price/earnings ratio
The P/E ratio is the measure which is used for assessing the value of the business
organization. The price here refers to the price of the stock of the company while earnings
means the net income which is being reported by the organization. For instance, if the stock
of the company is currently sold at the price of $24 per share while the organization reported
the EPS of $1.50, then the PER will be 16 (24/1.50).this is also referred to as multiples
(Rahmawati, Rahadi and Damayanti, 2018). This indicates that the investor is willing to pay
$24 for gaining $1.50 in earnings. Higher the ratio more favourable it is for the investors. The
PER of the similar organization within the same industry $8 which means the market value of
the company is $12 ($8* 1.5) which indicates the company is overvalued by $12 (24-12).
This, higher ratio depicts the stronger position of the entity while lower ratio requires to be
further investigated.
Determining the value of Trojan plc using price earnings ratio
Particulars Formula Amount
(in £m)
Distributable earnings 40.4
Numbers of shares outstanding 147
Market price per share (MPS) 3.89
Earnings per share (EPS)
Price earnings ratio of Aztec (MPS/EPS) 18.52
EPS of the Trojan 0.27
Value of the shares of Trojan (PER of Aztec * EPS of Trojan) 5.0004
Calculating the market value
Trojan plc
= Value of the shares of Trojan * Numbers of
shares outstanding
= 5.0004 * 147 735.06
Based on the above, it can be stated that the value of the Trojan plc is £735.06
million which is derived by using the PER. Under this, the market value is calculated through
multiplying the MPS with the number of shares.
b) Dividend valuation method
The DGM is used for the purpose of determining the fair value of the stocks of the
company which is based on the assumption that either dividend grows at the stable rate or at

different rate. It is useful in identifying whether the stock is under or over valued which
dependent upon the dividend GR assumption.This model is utilized for knowing the intrinsic
value of the stock which is based on the series of the dividends (Ferraro, 2017). This model
assumes that the dividend grows at the stable rate and thus, it is majorly useful for the
organization having stable growth rate. It mainly requires 3 inputs which are dividend per
share, GR and the expected rate of return. This model assumes that the company will exit
forever and will pay dividend to its investors at the constant rate. It determines the value
without taking into account other external factors or the prevailing market conditions.
Computation of the value of the company using dividend valuation method
Particulars Formula Amount (in
£m)
Details provided:
Latest dividend payment (Current dividend) 0.13
Growth rate (GR) = 0.10(1+g)^5
= 0.13
5.00%
0.05
Risk free rate (Rf) 5.00%
Beta (β) 1.10%
Number of shares 147
Return on market (Rm) 11.00%
For determining expected rate of return (K),
CAPM model will be used
According to CAPM, K is = Rf + (Rm-Rf)
* β
=5% + (11% -
5%) * 1.1%
5.07%
Market value per share
= 0.13 *
(1+5%)/(5.07%-
5%)
195