Question

Q14: Show Four (4) Intrinsic Valuation Methods for the following (Equations/Definitions): Give and Example!!!

Perpetuity Model:

Equation:

Example:

Gordon Growth:

Equation:

Example:

Multiple (P/E) Approach:

Equation:

Example:

Answer 1

A) Perpetuity Model: It is type of annuity that receives periodic cash flows indefinitely.

Equation: Value of Stock = (Cash Flow) / ( Discount Rate)

Example : If Company X receives cash flow USD 54 for indefinite period. Then what will be the value of the stock of company X. (Use discount rate 10%)

Value of stock X = (Cash Flow) / ( Discount Rate)

= 54 / 0.1 = 540

Value of stock X = USD 540

B) Gordon Growth Model: Also known as Dividend Discount Model (DDM) is used to calculate the intrinsic value of stock which is paying dividend that grow at constant rate.

Equation: Value of stock = ((Dividend) *(1+g))/( r-g).....Where r is required rate of return and g is constant growth in dividend

Example: Company Y currently pays USD 12 dividend per share which is expected to increase by 5% annually. The company requires minimum rate of return of 12%. Calculate the value of stock Y.

Value of stock = ((Dividend) *(1+g))/( r-g)

Value of stock = (12 * (1+0.05))/ (0.12-0.05) = USD 180.

C) Multiple P/E Approach: P/E approach helps us to calculate intrinsic value of stock using the comparative companies price and earnings.

Equation:

Value of stock = Avg P/E of comparative companies * Earnings of the company

Examples: Company X operates in FMCG sector where company A, Compnay B and company C operates. company A, Company B and company C have P/E as 14.5, 16.2, 15.8 respectively. Company X is having USD 124 of earnings for last period. Calculate value of stock X by using P/E approach

Avg P/E of comparative companies= (14.5+16.2+15.8) / 3 = 46.5/3 = 15.5

Value of stock = Avg P/E of comparative companies * Earnings of the company

= 15.5 * 124 = USD 1922