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Introduction: Valuation is the process of determining the worth of an asset. Broadly, the assets can be
classified into two parts, Physical assets and Financial assets. The physical assets refer to the assets like
Land, Building, Stock, Furniture, Machineries, etc. the financial assets refer to the financial claims such
as bonds (Debentures), Preference shares, equity shares etc. Every investor and finance manager must
understand how to value the financial assets to judge whether to invest in these securities or not.
A. Valuation of Bonds (Debentures): A bond or a debenture is a debt security issued by a borrower and
purchased by an investor. Bond is a usual source of long term financing.
(i) Par Value: The par value is also called the face value, the original value or the nominal value
of a bond. However, the issue price may be more than, may be less than, or may be equal to
the face value of the bond.
(ii) Coupon Rate: Coupon rate is the interest rate on a bond’s par value. A 10% debenture
implies that the firm has to pay 10% interest on the par value of the same debenture.
(iii) Maturity Period: The maturity period refers to the life of a bond in a firm. In other words, it
refers to the period from the date of issue till the redemption date. Generally, the firms issue
bonds of maturity period up to 10 years only.
• Valuation model for Redeemable Bonds: The value of a redeemable bond is the sum of the
present value of all the interest earnings and the redemption value of the same bond. So for
calculating the total value of a bond, we need to first calculate the present value of each year’s
interest, using the discounting factor (required rate of return) and present value of the Redemption
value, using the same discount rate.
• Valuation model for Irredeemable Bond: The value of irredeemable bond can be calculated by
dividing the Annual Interest payment (in rupee terms) by the Cost of bonds (required rate of
return on bonds).
In case of Semi-Annual Interest: In case, the firm decides to pay the interest on half-yearly
intervals, then the need valuation needs to be modified as follows:
(i) Find out the half-yearly amount of interest by dividing the annual interest by 2.
(ii) The number of years to maturity is to be multiplied by 2.
(iii) The annual required rate of return (discount rate) is also to be divided by 2.
• Valuation model for Redeemable Preference Shares: The valuation of the Redeemable
preference shares can be done using the same steps as we did in case of Bond Valuation. Only
one change has to be made and that is of Dividend in place of Interest as the shareholders are
entitled to receive dividend on shares.
• Valuation model for Irredeemable Preference Shares: The value of irredeemable preference
share can be calculated as dividing the Dividend per share (in rupee terms) by the Cost of
preference shares (required rate of return on preference shares).
Every company must have equity share capital as it represents the real ownership interest. The valuation
of the equity share is the most typical because of its residual ownership character. The equity shareholders
receive the residual profits if any after charging Interest on debt capital (debentures and long term loans),
and paying Dividend to preference shareholders
Valuation Models
1. ACCOUNTING BASIS: The value of an equity share is simply the value of firm’s ownership (based
on Balance Sheet values) divided by the number of equity shares.
2. DIVIDEND BASIS:
• Zero Growth Model: This is the simplest type of a dividend pattern in which the dividend
amount remains constant over years. The value of equity share can be calculated as dividing the
Dividend per share (in rupee terms) by the Cost of equity shares (required rate of return on equity
shares).
• Constant Growth Model: In this type of dividend pattern the dividend grows constantly at a rate
“g” every year. The value of equity share can be calculated as dividing the Dividend per share (in
rupee terms) by the Cost of equity shares (required rate of return on equity shares) less annual
growth rate in dividend.
3. EARNING BASIS:
• Gordon’s Model: The model is based on Earnings for equity shareholders and can be
represented as follows:
EPS (1-b)
Value of each share =
Ke – br
Where;
• Walter’s Model: This model is also based on Earnings for equity shareholders and can be
represented as follows:
D + (r / Ke) (E – D)
Value of each share = --------------------------
Ke
Where,