Valuation Methods in Financial Management

Financial Management

TABLE OF CONTENTS
Question 2..................................................................................................................................3
a) Price/earnings ratio............................................................................................................3
b) Dividend valuation method................................................................................................3
c) Discounted cash flow method............................................................................................4
d. Critical evaluation..............................................................................................................5
Question 3..................................................................................................................................7
1. Application of different investment appraisal techniques..................................................7
2. Benefits and limitations of different investment appraisal techniques............................11
REFERENCES.........................................................................................................................15

Question 2
a) Price/earnings ratio
The price earnings (P/E) ratio is the ratio which is commonly utilized by the
businesses for the purpose of measuring the stock value of the company in relation to its per
share earnings. This approach is useful for valuing the companies which is having a record of
profitable business (Susanti and Ilhami, 2018). This technique is mainly used in valuing the
quoted companies but it can also be utilized for valuing the unquoted companies as well. For
example, the after-tax profit of the organization is £200,000 and was offered £1,000,000, then
the PER will be 5. The quoted companies mainly have greater PER where a growing and
larger company will have excellent prospect having ratio in excess of 20. For deriving the
value of the company, the P/E ratio of the similarly quoted company is used.
MPS 3.89
EPS 0.21
P/E ratio of Aztec (A) 18.52
Distributable earnings 40.4
number of shares 147
EPS of trojan (B) 0.27
Value per share of Trojan (A * B) 5.0004
Total market value 735.06
Statement showing valuation using price earning ratio
The table given above shows the valuation of the Trojan plc using the PER valuation
method. The value derived under this method is £735.06.
b) Dividend valuation method
Under this technique, mostly the Gordon Growth model is utilized by the businesses for
the valuation purpose. This is based on the assumption that the dividend will continue rise at
the fixed rate of growth indefinitely. Using this assumption, one can determine the fair price
of the stock to be paid today in respect to the future payments for dividend (Sharma, Parekh
and Dhanuka, 2018). It is very straightforward approach for determining the price of the
stock using future dividends as the base. The valuation can be done using the formula P = D
(1- g) / (K-g). This method is mainly useful for valuing the minority stacks in an organization
instead of complete company.

Current dividend (D) 0.13
Risk free rate of return (Rf) 5%
Return on the market (Rm) 11%
Beta (ß) 1.10%
As per CAPM, the required rate of
return = Rf + (Rm-Rf)*ß
= 5% + (11% -5%) * 1.10%
Required rate of return (K) 5.07%
Growth rate 2%
Market price per share = D*(1+g) / (K-g)
= 0.13 * (1+2%) / (5.07% - 2%)
MPS 4.32
Total market value 635.04
Statement showing valuation using Dividend valuation method
The calculation given above states the market price of the Trojan plc using the
dividend valuation method and it has taken in account the dividend, expected ROR along the
constant growth rate (GR) of the organization. The value of the company derived is £635.04.
c) Discounted cash flow method
The discounting cash flow (DCF) method of business valuation is utilized for the
purpose of evaluating the attractiveness associated with the speculation opportunity. DCF
approach makes use of future FCF projections and then discounting it by considering the
WACC to show up at a current worth, which is utilized to assess the potential for speculation,
frequently at the time of due diligence (He and Long, 2019). In case, if the value showed up
at through DCF approach is greater in comparison to the current COI, then the prospect can
be considered as the good one. Under this approach, the intrinsic value of the investment is
determined using the fundamental concepts of this approach. This method is effective for the
business organizations whose cash flows are presently positive and the forecasting can eb
done with some sort of reliability along with the proxy for risk that can eb utilized for
attaining the discounting rate.