Investment Valuation in India

One of the methods of valuing a company based on Discounted Cash Flow Method is as follows: Value of the Company = Free Cash Flow for the Firm (FCFF) for next year / (Cost of Capital - Growth Rate) where: FCFF = EBIT next year x (1 - Tax Rate) x (1 - Reinvestment Rate) Cost of Capital is the Weighted Average Cost of Capital (WACC) i.e. Weight of Debt (Wd) x Cost of Debt (Kd) + Weight of Equity (We) x Cost of Equity (Ke) Reinvestment Rate represents the amount required to be invested in the company every year to keep the company looking good and working well, even if the company does not grow in size. Reinvestment Rate is calculated as Expected Growth rate (g) / Cost of Capital (Kc) Note this is a simplistic method of calculation and is just one of the many ways of calculating value of a company. The method assumes that the company is growing at a constant growth rate which may not be a fair assumption to make, especially in case of start-ups or companies underg...

RBI, wide notification no. Notification No. FEMA 20 / 2000-RB dated 3rd May, 2000 have amended the pricing and valuation guidelines for a private company issuing shares to a person resident outside India. RISGHTS ISSUE The offer on right basis to the persons resident outside India shall be at a price which is not less than the price at which the offer on right basis is made to resident shareholders. ISSUE OF SHARES Current Provision - Price of shares issued to persons resident outside India is required to be issued at a value arrived at by a Chartered Accountant who would determine the price in accordance with the erstwhile Controller of Capital Issues (CCI) Guidelines [conservative method of valuation by considering an average of the Net Asset Value (NAV) of the company and the company’s Profit Earning Capacity Value (PECV), which was arrived at based on its past financial performance]. Revised Guidelines - Price of shares issued to persons resident outside India, shall not be...

Gordon Model (Constant Growth rate) The Gordon model assumes a constant growth rate for infinity. The value of the stock is given by: V = D1 / (Re - g) Where, D1 = Expected dividend at the end of the year Re = Required rate of return on equity g = Expected growth rate for a long period of time (mathematically, infinite period) For example, A Ltd. Reported earnings per share (EPS) of Rs 15 last year and paid out 52% of its earnings as dividend. The earnings and dividends are expected to grow at the rate of 8% in the long term as in the past. If the required rate of return on equity shares of A Ltd. is 12%, the value of the security is calculated as follows; EPS = Rs 15 The Current dividend per share is given by the payout ratio times the EPS. Dividend per share (D0) = 15 x 0.52 = Rs. 7.8 So the expected dividend would be given by multiplying the current dividend with the expected growth rate. Dividend per share (D1) = 7.8 x 1.08 = Rs. 8.42 Expected growth rate = 8% Required rate of retu...

The term dividend refers to that part of after-tax profit which is distributed to the owners (shareholders) of the company. The undistributed part of the profit is known as Retained earnings. Higher the dividend payout, lower will be retained earnings. The dividend policy of a company refers to the views and policies of the management with respect of distribution of dividends. The dividend policy of a company should aim at shareholder-wealth maximization. The essence of dividend policy is: If the company is confident of generating more than market returns then only it should retain higher profits and pay less as dividends (or pay no dividends at all), as the shareholders can expect higher share prices based on higher RoI of the company. However, if the company is not confident of generating more than market returns, it should pay out more dividends (or 100% dividends). This is done for two reasons. One, the shareholders prefer early receipt of cash (liquidity preference theory) and sec...

Investment in Unlisted Equity Shares With a view to bringing about uniformity in calculation of NAVs of mutual funds schemes, the following guidelines are being issued for valuation of unlisted equity shares in consultation with Association of Mutual Funds in India (AMFI). The guidelines also prescribe exercise of due diligence while making such investments and review of their performance so as to protect the interests of investors. Methodology for Valuation Unlisted equity shares of a company shall be valued "in good faith" on the basis of the valuation principles laid down below: Based on the latest available audited balance sheet, net worth shall be calculated as lower of (i) and (ii) below: (i) Net worth per share = [share capital plus free reserves (excluding revaluation reserves) minus Miscellaneous expenditure not written off or deferred revenue expenditure, intangible assets and accumulated losses] divided by Number of Paid up Shares. (ii) After taking into account th...