Question

​Valuation of Securities​​​​​​​

i) Briefly explain the different basis of Valuation of Shares.​​​​

ii) Easy plc has just paid the dividend of 50p. The expected Return is 20% and 60% of the Profits are divided. Average Market Returns are 12% and the Return on Govt. Bond is 4% and Beta of the Security is 1.2

Requirement​​​​​​​​

​Determine the Market Price of the Share.

Answer 1

Following are different basis of valuation of shares:

1. Assets Approach

If a company is capital-intensive company and invested a large amount in capital assets then asset-based approach is used.

2. Income Approach

This approach uses two different methods Discounted Cash Flow (DCF) or Price Earning Capacity (PEC) method. DCF method uses the projection of future cash flows to determine the fair value and if this data is reasonably available, DCF method can be used. PEC method uses historical earnings and if an entity is not in the business for a long time and just started its operations, then this method cannot be applied.

3. Market Approach

Under this approach, the market value of the shares is considered for valuation. However, this approach is feasible only for listed companies whose share prices can be obtained in the open market. If there are set of peer companies which are listed and engaged in the similar business, then such company’s share public prices can also be used.

As per CAPM, Cost of Equity= Risk Free rate of Interest+ Beta (Mark Risk Premium)

0.04+ 1.2 ( 0.12-0.04)

13.60%

Market Value of equity

Dividend/ expected rate of return

(0.50/0.1360)

3.676470588