Valuation of Shares | Dividend and Growth Rate

Case study-1
Part A
In the first case, valuation of shares need to be done on the basis of dividend and
growth rate wherein high growth rate shall persist for a period of 4 years (say
8%) and thereafter it shall reduce to a lower rate (say 4%). The initial dividend is
assumed to be $10 and the cost of capital is assumed to be 6%. Based on above
assumptions, the valuation of share shall be determined at $ 228.72.
Accordingly, the shares shall be purchased when the purchase price is below the
valuation price and shall not be purchased when valuation price is below the
purchase price.
The computation is shown as under:
Initial Dividend: 10
High Growth: 8%
Low Growth: 4%
Share Price= 10.8/1.06+ 11.66/(1.06^2)+12.60/(1.06^3)+
13.61/(1.06^4)+235.81/(1.06^4)=228.72
Initial
Dividend
Amount
Gro
wth
Dividend in
Future
Terminal
Value
Discountin
g Factor
Discounte
d Value
10 1.08 10.8 1.06
10.1886792
5
10.8 1.08 11.664 1.1236
10.3809184
8
11.664 1.08 12.59712 1.191016
10.5767848
6
12.59712 1.08 13.6048896 1.26247696
10.7763468
4
13.6048896 1.04
14.1490851
8
235.8180
864 1.26247696
186.790011
9
Share Value at present
228.712741
3
Thus, on the basis of above it may be inferred that the resultant investment will
have positive value when the current share price is below $228.71. Let us
understand the same with an example:
For instance the current share price is 210, then buying the share shall be a
feasible option under the current price as the valuation is higher and thus
purchase shall contribute positively to the valuation of the holder.
On the other hand, if the current share price is 230, then buying the share shall
not be a feasible option under the current price as the valuation is lower and
thus purchase shall contribute negatively to the valuation of the holder

Part B
EBIT for previous year : 100
Growth rate of EBIT: 10%
Depreciation for previous year: 10
Capital investment each year as percentage of EBIT: 20%
Corporate Tax Rate: 30%
Weighted Average Cost of Capital: 10%
Amount of Debt Out Standing: 500
Change in Working Capital: -200
Growth rate of Depreciation : 10%
Based on above details, the computation is done in the following manner:
Step 1: Compute Earnings Before interest and tax which in the current case is
100
Step 2: Compute the EBIT value post tax @ 30% which comes to 70
Step 3: Add depreciation to the value derived in step 2 which is 10
Step 4: Reduce the amount of capital investment made during the year i.e. 20
Step 5: Reduce the amount of increase in the working capital which in the
current case is 200 implying that there is decrease in working capital
Accordingly, Free cash flow to firm is : 100(1-30%)+10-20+200=260
Case study-2
Computation of Duration of Bond
Bond time to maturity : 5 years
Interest Rate : 8% compounding semi annually means 4%
WACC: 10% or 5% Semi annually
Computation of duration of bond
Time Period
Inter
est Discounting Value
Time Period
* value
1 4 0.952380952
3.8095238
1 3.80952381
2 4 0.907029478
3.6281179
14 7.256235828
3 4 0.863837599
3.4553503
94 10.36605118
4 4 0.822702475
3.2908098
99 13.1632396
5 4 0.783526166 3.1341046 15.67052333