Valuation of Equity Share Prices

8/7/2019 Valuation of Equity Share Prices

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VALUATION OF EQUITY SHARE PRICES

A DISSERTATON SUBMITTED IN PARTIAL FULFILMENT OF THE

REQUIREMENTS FOR THE AWARD OF MBA DEGREE OFBANGALORE UNIVERSITY

SUBMITTED BY

DANTULURI S HARSHA VARMA

Reg.No-06XQCM6069

Under the Guidance and Supervision

Of

PROF.PRAVEEN BHAGAWAN

M P BIRLA INSTITUTE OF MANAGEMENTAssociate Bharatiya Vidya Bhavan

#43, Race Course Road, BANGALORE. 560001

2006-2008


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VALUATIONOFEQUITYSHAREPRICES2008

MPBIRLAINSTITUTEOFMANAGEMENT Page2

STUDENT DECLARATION

I hereby declare that this dissertation entitled a study on VALUATION

OF EQUITY SHARE PRICES is the result of my own research work carried

out by me, under the guidance and supervision o f PROF. PRAVEEN

BHAGAWAN, M. P Birla Institute of Management, Bangalore. I also

declare that this dissertation has not been submitted earlier to any

Institute/organization for the award of any degree or diploma.

Place: Bangalore DANTULURI S HARSHA VARMA

Date: (06XQCM6069)


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PRINCIPALS CERTIFICATE

This is to certify that this dissertation entitled VALUATION OF

EQUITY SHARE PRICES is the result of research work carried out by

Mr. Dantuluri S Harsha Varma (REG 06XQCM6069) under the guidance

and supervision ofProf.Praveen baghwan, Senior Professor , M.P. Birla

Institute ofManagement, Bangalore.

Plac e: Banga lore Dr. NAGESH S. MALAVALLI

Date: Principal


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GUIDES CERTIFICATE

I here by cetify that the Dissertation entitled VALUATION OF EQUITY

SHARE PRICES is the project work carried out byMr. Dantuluri S Harsha

varma bearing registration number 06XQCM6069 under my guidance and

supervision as per the requirements of the Bangalore University, MBA

syllabus. This report has not formed the basis for the award of any other

degree.

Place: Bangalore Prof. PRAVEEN BHAGAWAN

Date: Faculty (MPBIM)


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ACKNOWLEDGEMENT

This project is made successful by the combining efforts of a no. of officials

whose knowledge and experience have helped me a lot. This project can

not be said completed unless and until, I fulfill my duty of thanking those

persons to whom I deeply indebted. I wish to express my deep gratitude

towards them to their whole hearted support and existence.

First, I would like to thank Dr. N.S. MALAVALLI, Principal, M.P Birla

Institute of Management for his kind support and giving me the opportunity

to present this project.

I am extremely thankful to, Prof. Praveen Bhagawan,M.P. Birla Institute

of Management, Bangalore, who has guided me to do this project by

giving valuable suggestion and advice.

At the end I am also thankful to my parents and my friends to help me in

preparing my report.

Place: Bangalore DANTULURI S HARSHA VARMA

Date: (06XQCM6069)


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Contents

ABSTRACT .................................................................................................7

CHAPTER 1.................................................................................................9INTERDICTION1.1INTRODUCTION...........................................................9

1.1INTRODUCTION...................................................................................10

1.2OVERVIEWOFVALUATION................................................................111.3THEROLEOFVALUATION .................................................................11

1.7RESEARCH PROPOSAL.....................................................................32

1.7.1PROBLEMSTATEMENT:-.................................................................321.7.2OBJECTIVES:-...................................................................................32

1.7.3SCOPEOFSTUDY:-..........................................................................32

CHAPTER 2...............................................................................................33

2.1LITERATURE REVIEW ........................................................................34

CHAPTER 3...............................................................................................43

3.1RESEARCH METHODOLOGY ............................................................44

3.1.1TYPEOFRESEARCH .......................................................................443.1.2SAMPLINGTECHNIQUE...................................................................44

3.1.3DATACOLLECTION..........................................................................443.1.4SOURCESOFDATA .........................................................................44

3.1.5DATA REQUIRED AND PERIOD OF STUDY...................................45

CHAPTER 4...............................................................................................46

4.1ANALYSIS & INTERPRETATION........................................................47

4.2FREECASHFLOWTOEQUITYMODEL .............................................474.4PEMULTIPLIERMODEL......................................................................754.5RELATIVECOMPARISONOFCOMPANIES .......................................76

4.6CONCLUSION:-....................................................................................79BIBLIOGRAPHY........................................................................................82


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LIST OF TABLES

FREE CASH FLOWS TO EQUITY METHOD TABLES

4.2.1INFOSYS TECHNOLOGY LTD 39

4.2.2HCL TECHNOLOGIES LTD 40

4.2.3SATYAM COMPUTERS LTD 42

4.2.4TECH MAHINDRA LTD 43

4.2.5I-FLEX SOLUTIONS 45

4.2.6MPHASIS LTD 48

4.2.7PATNI COMPUTERS 49

4.2.8POLARIS SOFTWARE 50

4.2.9WIPRO LTD 51

4.2.10TCS 53

DIVIDENT DISCOUNT MODEL TABLES

4.3.1INFOSYS TECHNOLOGY 55

4.3.2HCL TECHNOLOGIES 56

4.3.3SATYAM COMPUTERS LTD 57

4.3.4I-FLEX SOLUTIONS 58

4.3.5MPHASIS LTD 59

4.3.6PATNI COMPUTERS 60

4.3.7POLARIS SOFTWARE 61

4.3.8WIPRO TECHNOLOGIES LTD 62

4.3.9TCS 63

4.3.10TECH MAHINDRA 64

4.4PE MULTIPLIER MODEL 65

4.5RELATIVE COMPARISON OF COMPANIES 66

4.6.1CONSOLIDATED RESULTS 69


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ABSTRACT

Valuation is the process of determining the real value (intrinsic value) as opposed to the

observed market price of a security.

Different methods give different intrinsic value of company and also in each method

there are different growth and different forces which drive the security price the problem

lies in which intrinsic value to choose.

In this project four different methods namely free cash flows to equity, dividend discountmodel, PE multiplier model and relative comparison of companies are done and the

drivers of each model are calculated.

One industry namely large capitalization information technology (IT) is considered and

ten companies in IT large cap industry are analysis and the intrinsic value for these

companies is calculated using four methods which considered.

In each method the market value is compared with the intrinsic value for each company

and whether the share price is over valued or under valued is decided.

Finally the market price is compared with the intrinsic values of four methods and a

consolidated, that is whether market share price is is over valued or under valued is

decided.


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CHAPTER 1

INTRODUCTION


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1.1INTRODUCTION

Every asset, financial as well as real, has a value. The key to successfully investing in

and managing these assets lies in understanding not only what the value is but also the

sources of the value. Any asset can be valued, but some assets are easier to value than

others and the details of valuation will vary from case to case. Thus, the valuation of a

share of a real estate property will require different information and follow a different

format than the valuation of a publicly traded stock. What is surprising; however, is not

the difference in valuation techniques across assets, but the degree of similarity in basic

principles. There is undeniably uncertainty associated with valuation. Often that

uncertainty comes from the asset being valued, though the valuation model may add to

that uncertainty.

In the wake of economic liberalization, companies are relying more on the capital

market, acquisitions and restructuring are becoming common place, strategic alliances

are gaining popularity, employee stock option plans are proliferating, and regulatory

bodies are struggling with tariff determination. In these exercises a crucial issue is: how

should the value of a company or a division thereof is appraised.

The goal of such an appraisal is essentially to estimate a fair market value of a

company. The fair market value is the price at which the property would change hands

between a willing buyer and a willing seller when the former is not under any

compulsion to buy and the latter is not under any compulsion to sell, both parties having

reasonable knowledge of relevant facts. When the asset being appraised is a company,

the property the buyer and the seller are trading consists of the claims of all the

investors of the company; this includes outstanding equity shares, preference shares,

debentures and loans.


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1.2OVERVIEW OF VALUATION

Analysts use a wide spectrum of models, ranging from the simple to the sophisticated.

These models often make very different assumptions about the fundamentals that

determine value, but they do share some common characteristics and can be classified

in broader terms. There are several advantages to such a classification --it makes it is

easier to understand where individual models fit in to the big picture, why they provide

different results and when they have fundamental errors in logic.

In general terms, there are four approaches to valuation. The first, discounted cashflowvaluation, relates the value of an asset to the present value of expected future

cashflows on that asset. The second, liquidation and accounting valuation is built

around valuing the existing assets of a firm, with accounting estimates of value or book

value often used as a starting point. The third, relative valuation, estimates the value of

an asset by looking at the pricing of 'comparable' assets relative to a common variable

like earnings, cashflows, book value or sales. The final approach, contingent claim

valuation, uses option pricing models to measure the value of assets that share option

characteristics. This is what generally falls under the rubric of real options.

1.3THE ROLE OF VALUATION

Valuation is useful in a wide range of tasks. The role it plays however is different in

different arenas. The following section lays out the relevance of valuation in portfolio

management, in acquisition analysis, and in corporate finance.

1.3.1VALUATION AND PORTFOLIO MANAGEMENT

The role that valuation plays in portfolio management is determined in large part by the

investment philosophy of the investor. Valuation plays a minimal role in portfolio

management for a passive investor, whereas it plays a larger role for an active investor.

Even among active investors, the nature and the role of valuation is different for


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different types of active investment. Market timers use valuation much less than

investors who pick stocks and the focus is on market valuation rather than on firm-

specific valuation. Among security selectors, valuation plays a central role in portfoliomanagement for fundamental analysts and a peripheral role for technical analysts.

1.3.2VALUATION IN ACQUISITION ANALYSIS

Valuation should play a central part in acquisition analysis. The bidding firm or individual

has to decide on a fair value for the target firm before making a bid, and the target firm

has to determine a reasonable value for itself before deciding to accept or reject the

offer. There are also special factors to consider in takeover valuation. First the effects of

synergy on the combined value of the two firms (target plus bidding firm) have to be

considered before a decision is made on the bid. Those who suggest that synergy is

impossible to value and, therefore should not be considered in quantitative terms are

wrong. Second the effects on value of changing management and restructuring the

target firm will have to be taken into account in deciding on a fair price. This is of

particular concern in hostile takeovers. Finally there is a significant problem with bias in

the takeover valuations. Target firms may be overoptimistic in estimating value,

especially when the takeover is hostile and they are trying to convince their

shareholders that the offer price is too low. Similarly if the bidding firm has decided, for

strategic reasons, to do an acquisition, there may be strong pressure on the analyst to

come up with an estimate of value that backs up the acquisition.

1.3.3VALUATION IN CORPORATE FINANCE

In recent years, management consulting firms have started offering companies advice

on how to increase value. This has been possible because of the fear of hostile

takeovers. Companies have increasingly turned to .value consultants. To tell them how

to restructure, increase value, and avoid being taken over. The consultants.

Suggestions have often provided the basis for the restructuring of these firms. The

value of a firm can be directly related to decisions that it makes: on which projects it


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takes, on how it finances them, and on its dividend policy. Understanding this

relationship is key to making value increasing decisions and to sensible financial

restructuring.

1.4APPROACHES TO VALUATION

There are four broad approaches to appraising the value of a company namely

1. Adjusted book value approach

2. Stock and debt approach

3. Relative Valuation and

4. Discounted cash flow approach.

1.4.1ADJUSTED BOOK VALUE APPROACH

The simplest approach to valuing a firm is to rely on the information found on its balance

sheet. There are two equivalent ways of using the balance sheet information to appraise

the value of a firm. First, the book values of investor claims may be summed directly.

Second, the assets of a firm may be totaled and from this total non-investor claims (like

accounts payable and provisions) may be deducted. The accuracy of the book value

approach depends on how well the net book values of the assets reflect their fair market

values.

1.4.2STOCK AND DEBT APPROACH

When the securities of a firm are publicly traded, its value can be obtained by merely

adding the market value of all its outstanding securities. This simple approach is called

the stock and the debt approach by property tax appraisers. It is also referred to as the

market approach.


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1.4.3Relative Valuation

While we tend to focus most on discounted cash flow valuation, when discussing

valuation, the reality is that most valuations are relative valuations. The value of most

assets, from the house you buy to the stocks that you invest in, are based upon how

similar assets are priced in the market place. We begin this section with a basis for

relative valuation, move on to consider the underpinnings of the model and then

consider common variants within relative valuation.

In relative valuation, the value of an asset is derived from the pricing of 'comparable'

assets, standardized using a common variable such as earnings, cash flows, book

value or revenues. One illustration of this approach is the use of an industry-average

price-earnings ratio to value a firm. This assumes that the other firms in the industry are

comparable to the firm being valued and that the market, on average, prices these firms

correctly. Another multiple in wide use is the price to book value ratio, with firms selling

at a discount on book value, relative to comparable firms, being considered

undervalued. The multiple of price to sales is also used to value firms, with the average

price-sales ratios of firms with similar characteristics being used for comparison. While

these three multiples are among the most widely used, there are others that also play a

role in analysis - price to cash flows, price to dividends and market value to replacement

value (Tobin's Q), to name a few.

Categorizing Relative Valuation Models

Analysts and investors are endlessly inventive when it comes to using relative valuation.

Some compare multiples across companies, while others compare the multiple of a

company to the multiples it used to trade in the past. While most relative valuations are

based upon comparables, there are some relative valuations that are based upon

fundamentals.


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1. Using Fundamentals

The first approach relates multiples to fundamentals about the firm being valued growth rates in earnings and cashflows, payout ratios and risk. This approach to

estimating multiples is equivalent to using discounted cashflow models, requiring the

same information and yielding the same results. Its primary advantage is to show the

relationship between multiples and firm characteristics, and allows us to explore how

multiples change as these characteristics change. For instance, what will be the effect

of changing profit margins on the price/sales ratio? What will happen to price-earnings

ratios as growth rates decrease? What is the relationship between price-book value

ratios and return on equity?

2. Using Comparables

The more common approach to using multiples is to compare how a firm is valued with

how similar firms are priced by the market, or in some cases, with how the firm was

valued in prior periods. As we will see in the later chapters, finding similar and

comparable firms is often a challenge and we have to often accept firms that are

different from the firm being valued on one dimension or the other. When this is the

case, we have to either explicitly or implicitly control for differences across firms on

growth, risk and cash flow measures. In practice, controlling for these variables can

range from the naive(using industry averages) to the sophisticated (multivariate

regression models where the relevant variables are identified and we control for

differences.).

3. Cross Sectional versus Time Series Comparisons

In most cases, analysts price stocks on a relative basis by comparing the multiple it is

trading to the multiple at which other firms in the same business are trading. In some

cases, however, especially for mature firms with long histories, the comparison is done

across time.

a. Cross Sectional Comparisons


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When we compare the price earnings ratio of a software firm to the average price

earnings ratio of other software firms, we are doing relative valuation and we are

making cross sectional comparisons. The conclusions can vary depending upon ourassumptions about the firm being valued and the comparable firms. For instance, if we

assume that the firm we are valuing is similar to the average firm in the industry, we

would conclude that it is cheap if it trades at a multiple that is lower than the average

multiple. If, on the other hand, we assume that the firm being valued is riskier than the

average firm in the industry, we might conclude that the firm should trade at a lower

multiple than other firms in the business. In short, you cannot compare firms without

making assumptions about their fundamentals.

b. Comparisons across time

If you have a mature firm with a long history, you can compare the multiple it trades

today to the multiple it used to trade in the past. Thus, Ford Motor company may be

viewed as cheap because it trades at six times earnings, if it has historically traded at

ten times earnings. To make this comparison, however, you have to assume that your

firm has not changed its fundamentals over time. For instance, you would expect a high

growth firms price earnings ratio to drop and its expected growth rate to decrease over

time as it becomes larger. Comparing multiples across time can also be complicated by

changes in the interest rates over time and the behavior of the overall market. For

instance, as interest rates fall below historical norms and the overall market increases,

you would expect most companies to trade at much higher multiples of earnings and

book value than they have historically.

1.4.4Standardized Values and Multiples

The price of a stock is a function both of the value of the equity in a company and the

number of shares outstanding in the firm. Thus, a stock split that doubles the number of

units will approximately halve the stock price. Since stock prices are determined by the

number of units of equity in a firm, stock prices cannot be compared across different


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firms. To compare the values of similar firms in the market, you need to standardize

the values in some way. Values can be standardized relative to the earnings firms

generate, to the book value or replacement value of the firms themselves, to therevenues that firms generate or to measures that are specific to firms in a sector.

1. Earnings Multiples

One of the more intuitive ways to think of the value of any asset is the multiple of the

earnings that asset generates. When buying a stock, it is common to look at the price

paid as a multiple of the earnings per share generated by the company. This

price/earnings ratio can be estimated using current earnings per share, yielding a

current PE, earnings over the last 4 quarters, resulting in a trailing PE, or an expected

earnings per share in the next year, providing a forward PE.

When buying a business, as opposed to just the equity in the business, it is common to

examine the value of the firm as a multiple of the operating income or the earnings

before interest, taxes, depreciation and amortization (EBITDA). While, as a buyer of the

equity or the firm, a lower multiple is better than a higher one. These multiples will be

affected by the growth potential and risk of the business being acquired.

2. Book Value or Replacement Value Multiples

While markets provide one estimate of the value of a business, accountants often

provide a very different estimate of the same business. The accounting estimate of book

value is determined by accounting rules and is heavily influenced by the original price

paid for assets and any accounting adjustments (such as depreciation) made since.

Investors often look at the relationship between the price they pay for a stock and the

book value of equity (or net worth) as a measure of how over- or undervalued a stock is;

the price/book value ratio that emerges can vary widely across industries, depending

again upon the growth potential and the quality of the investments in each. When

valuing businesses, you estimate this ratio using the value of the firm and the book

value of all assets (rather than just the equity). For those who believe that book value is

not a good measure of the true value of the assets, an alternative is to use the


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replacement cost of the assets; the ratio of the value of the firm to replacement cost is

called Tobins Q.


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3. Revenue Multiples

Both earnings and book value are accounting measures and are determined by

accounting rules and principles. An alternative approach, which is far less affected byaccounting choices, is to use the ratio of the value of an asset to the revenues it

generates. For equity investors, this ratio is the price/sales ratio (PS), where the market

value per share is divided by the revenues generated per share. For firm value, this

ratio can be modified as the value/sales ratio (VS), where the numerator becomes the

total value of the firm. This ratio, again, varies widely across sectors, largely as a

function of the profit margins in each. The advantage of using revenue multiples,

however, is that it becomes far easier to compare firms in different markets, with

different accounting systems at work, than it is to compare earnings or book value

multiples.

4. Sector-Specific Multiples

While earnings, book value and revenue multiples are multiples that can be computed

for firms in any sector and across the entire market, there are some multiples that are

specific to a sector. For instance, when Internet firms first appeared on the market in the

later 1990s, they had negative earnings and negligible revenues and book value.

Analysts looking for a multiple to value these firms divided the market value of each of

these firms by the number of hits generated by that firms web site. Firms with a low

market value per customer hit were viewed as more under valued. More recently,

retailers have been judged by the market value of equity per customer in the firm,

regardless of the longevity and the profitably of the customers.

While there are conditions under which sector-specific multiples can be justified, they

are dangerous for two reasons. First, since they cannot be computed for other sectors

or for the entire market, sector-specific multiples can result in persistent over or under

valuations of sectors relative to the rest of the market. Thus, investors who would never

consider paying 80 times revenues for a firm might not have the same qualms about

paying Rs 2000 for every page hit (on the web site), largely because they have no

sense of what high, low or average is on this measure. Second, it is far more difficult to


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relate sector specific multiples to fundamentals, which is an essential ingredient to using

multiples well. For instance, does a visitor to a companys web site translate into higher

revenues and profits? The answer will not only vary from company to company, but willalso be difficult to estimate looking forward.

1.5Discounted Cash flow Valuation

1.5.1Basis for Discounted Cash flow Valuation

This approach has its foundation in the present value rule, where the value of any asset

is the present value of expected future cash flows that the asset generates.

Value =

Where,

n = Life of the asset

CFt = Cashflow in period t

r = Discount rate reflecting the riskiness of the estimated cashflows.

The cashflows will vary from asset to asset -- dividends for stocks, coupons (interest)

and the face value for bonds and after-tax cashflows for a real project. The discount rate

will be a function of the riskiness of the estimated cashflows, with higher rates for riskier

assets and lower rates for safer projects. You can in fact think of discounted cash flow

valuation on a continuum. At one end of the spectrum, you have the default-free zero

coupon bond, with a guaranteed cash flow in the future. Discounting this cash flow atthe riskless rate should yield the value of the bond. A little further up the spectrum are

corporate bonds where the cash flows take the form of coupons and there is default

risk. These bonds can be valued by discounting the expected cash flows at an interest

rate that reflects the default risk. Moving up the risk ladder, we get to equities, where

there are expected cash flows with substantial uncertainty around the expectation. The


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value here should be the present value of the expected cash flows at a discount rate

that reflects the uncertainty.


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1.5.2Categorizing Discounted Cash Flow Models

There are literally thousands of discounted cash flow models in existence. Oftentimes,we hear claims made by investment banks or consulting firms that their valuation

models are better or more sophisticated than those used by their contemporaries.

Ultimately, however, discounted cash flow models can vary only a couple of dimensions

and we will examine these variations in this section.

1.5.3Total Cash Flow versus Excess Cash Flow Models

The conventional discounted cash flow model values an asset by estimating the present

value of all cash flows generated by that asset at the appropriate discount rate. In

excess return (and excess cash flow) models, only cash flows earned in excess of the

required return are viewed as value creating, and the present value of these excess

cash flows can be added on to the amount invested in the asset to estimate its value.

Excess return = Cash flow earned Cost of capital * Capital Invested in asset

1.5.4free cash flow to equity discount models

The dividend discount model is based upon the premise that the only cashflows

received by stockholders is dividends. Even if we use the modified version of the model

and treat stock buybacks as dividends, we may misvalue firms that consistently return

less or more than they can afford to their stockholders.

1.5.5Free Cash Flows to Equity

To estimate how much cash a firm can afford to return to its stockholders, we begin with

the net income the accounting measure of the stockholders earnings during the

period and convert it to a cash flow by subtracting out a firms reinvestment needs.

First, any capital expenditures, defined broadly to include acquisitions, are subtracted

from the net income, since they represent cash outflows. Depreciation and amortization,


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on the other hand, are added back in because they are non-cash charges. The

difference between capital expenditures and depreciation is referred to as net capital

expenditures and is usually a function of the growth characteristics of the firm. High-growth firms tend to have high net capital expenditures relative to earnings, whereas

low-growth firms may have low, and sometimes even negative, net capital expenditures.

Second, increases in working capital drain a firms cash flows, while decreases in

working capital increase the cash flows available to equity investors. Firms that are

growing fast, in industries with high working capital requirements (retailing, for instance),

typically have large increases in working capital. Since we are interested in the cash

flow effects, we consider only changes in non-cash working capitalin this analysis.

Finally, equity investors also have to consider the effect of changes in the levels of debt

on their cash flows. Repaying the principal on existing debt represents cash outflow; but

the debt repayment may be fully or partially financed by the issue of new debt, which is

a cash inflow. Again, netting the repayment of old debt against the new debt issues

provides a measure of the cash flow effects of changes in debt.

Allowing for the cash flow effects of net capital expenditures, changes in working capital

and net changes in debt on equity investors, we can define the cash flows left over after

these changes as the free cash flow to equity (FCFE).

Free Cash Flow to Equity (FCFE) = Net Income

- (Capital Expenditures - Depreciation)

- (Change in Non-cash Working Capital)

+ (New Debt Issued - Debt Repayments)

This is the cash flow available to be paid out as dividends or stock buybacks.

This calculation can be simplified if we assume that the net capital expenditures and

working capital changes are financed using a fixed mix1 of debt and equity.


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1.5.6The Free Cashflow to the Firm

The free cashflow to the firm is the sum of the cashflows to all claim holders in the firm,

including stockholders, bondholders and preferred stockholders. There are two ways of

measuring the free cashflow to the firm (FCFF). One is to add up the cashflows to the

claim holders, which would include cash flows to equity (defined either as free cash flow

to equity or dividends), cashflows to lenders (which would include principal payments,

interest expenses and new debt issues) and cash flows to preferred stockholders

(usually preferred dividends).

FCFF = Free Cashflow to Equity + Interest Expense (1 - tax rate) + PrincipalRepayments - New Debt Issues+ Preferred Dividends

Note, however, that we are reversing the process that we used to get to free cash flow

to equity, where we subtracted out payments to lenders and preferred stockholders to

estimate the cash flow left for stockholders. A simpler way of getting to free cash flow to

the firm is to estimate the cash flows prior to any of these claims. Thus, we could begin

with the earnings before interest and taxes, net out taxes and reinvestment needs and

arrive at an estimate of the free cash flow to the firm.

FCFF = EBIT (1 - tax rate) + Depreciation - Capital Expenditure - Working Capital

Since this cash flow is prior to debt payments, it is often referred to as an unlevered

cash flow. Note that this free cash flow to the firm does not incorporate any of the tax

benefits due to interest payments. This is by design, because the use of the after-tax

cost of debt in the cost of capital already considers this benefit and including it in the

cash flows would double count it.


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The Model

The value of the firm, in the most general case, can be written as the present value ofexpected free cashflows to the firm.

Value of Firm =

Where,

FCFFt = Free Cashflow to firm in year t.

WACC = Weighted average cost of capital.

DIVIDEND DISCOUNT MODELS

In the strictest sense, the only cash flow you receive from a firm when you buy publicly

traded stock is the dividend. The simplest model for valuing equity is the dividend

discount model -- the value of a stock is the present value of expected dividends on it.

While many analysts have turned away from the dividend discount model and viewed itas outmoded, much of the intuition that drives discounted cash flow valuation is

embedded in the model. In fact, there are specific companies where the dividend

discount model remains a useful took for estimating value.

The General Model

When an investor buys stock, she generally expects to get two types of cashflows -

dividends during the period she holds the stock and an expected price at the end of the

holding period. Since this expected price is itself determined by future dividends, the

value of a stock is the present value of dividends through infinity.


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Value per share of stock =

Where,

DPSt = Expected dividends per share

Ke = Cost of equity

There are two basic inputs to the model - expected dividends and the cost on equity. To

obtain the expected dividends, we make assumptions about expected future growth

rates in earnings and payout ratios. The required rate of return on a stock is determined

by its riskiness, measured differently in different models - the market beta in the CAPM,

and the factor betas in the arbitrage and multi-factor models. The model is flexible

enough to allow for time-varying discount rates, where the time variation is caused by

expected changes in interest rates or risk across time.

The Gordon Growth Model

The Gordon growth model can be used to value a firm that is in 'steady state' with

dividends growing at a rate that can be sustained forever.

The Model

The Gordon growth model relates the value of a stock to its expected dividends in the

next time period, the cost of equity and the expected growth rate in dividends.

Value of Stock =

Where,

DPS1 = Expected Dividends one year from now (next period)

Ke = Required rate of return for equity investors

G = Growth rate in dividends forever


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1.6METHODS USED FOR VALUATIONS:-

VALUATION PARAMETERS:-

The following parameters are used for valuing the companies:-

1. Net operating profit less adjusted taxes (NOPLAT)

2. Return on capital employed (ROCE)

3. Growth rate

4. Weighted average cost of capital

5. Free cash flow (FCFF)

As per the sample size ten companies representing information technology industry areanalyzed by four different techniques those are

1. Free cash flows to equity.

2. Dividend discount model.

3. PE ratio method.

4. Direct comparison approach.


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1.6.1Free cash flows to equity:-

Value of high - growth business =

Free cash flows to firm

PARTICULARS AMOUN

SALES XXX

LESS:-COGS XXX

EBIT XXX

LESS:-TAX XXX

EBIT (1-T) XXX

LESS: - CHANGE IN WORKING CAPITAL XXX

FCFF XXX

Assumption: - In the long run both capital expenditure and depreciation with equal and

cancel off each other.

Now free cash flow to firm (FCFF) is estimated for next 5 years and then terminal value

of the firm is calculated. These FCFF are discounted to present value by using weighted

average cost of capital (WACC).


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1.6.2TERMINAL VALUE

The terminal value of a security is the present value at a future point of all future cash

flows. It allows for the inclusion of the value of future cash flows occurring beyond a

several year projection period while satisfactorily mitigating many of the problems of

valuing such cash flows. The terminal value is calculated in accordance with a stream of

projected future free cash flows in discounted cash flow analysis.

Terminal value=final projected year cash flow/ (WACC-growth rate)

Once the terminal values and operating cash flows have been estimated, they are

discounted back to the present to yield the value of the operating assets of the firm.

Fair value of equity = FCFF - Total Debt.

Value of each equity share = fair value of equity/total number of equity shares.

ESTIMATING SALES:-

The sale of last 4 years is considered and the growth rate of sales for 3 years iscalculated and weights of 0.4, 0.3 & 0.3 are given 0.4 is given to most resent year.

Average growth rate is calculated and taking this rate next 6 years sales is projected.

ESTIMATING EBIT:-Earning before interest and tax (EBIT) is calculated for first 3 years using financialstatements for the next 6 years the EBIT is projected using the growth rate of EBIT.

Growth rate in EBIT = Reinvestment Rate*Return on capital employed

Reinvestment rate = Capital expenditure-depreciation+change in non cash working capitalEBIT (1-Tax)

Return on capital employed = net earningsCapital employed


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ESTIMATING TAX & CHANGE IS WORKING CAPITAL:-

For tax purpose standard value of 33.66% is taken which is tax right now and for

change is working capital the working capital is estimated for next 6 years using sales

that is the working capital will change in proportion of sales.

1.6.3Dividend discount model:-

The Gordon Growth Model

The Gordon growth model can be used to value a firm that is in 'steady state' with

dividends growing at a rate that can be sustained forever. The Gordon growth model

relates the value of a stock to its expected dividends in the next time period, the cost of

equity and the expected growth rate in dividends.

Value of Stock = DPS1Ke g

Where,DPS1 = Expected Dividends one year from now (next period)Ke= required rate of return for equity investorsg = Growth rate in dividends forever

g =Growth rate = ROC* b

Where,

Roc = return on equity & b = retention ratio.

DPS1 = DPS0 (1+g).

Here ke is calculated using share price of stock for last 5 years. Roc & b are calculatedfor last 5 years using financial statements of those companies.


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1.6.4Price Earnings Ratio (PE)

The price-earnings multiple (PE) is the most widely used and misused of all multiples.

Its simplicity makes it an attractive choice in applications ranging from pricing initial

public offerings to making judgments on relative value, but its relationship to a firm's

financial fundamentals is often ignored, leading to significant errors in applications.

Definitions of PE ratio

The price earnings ratio is the ratio of the market price per share to the earnings per

share.

PE ratio Market price per share

Earnings per share

The PE ratio is consistently defined, with the numerator being the value of equity per

share and the denominator measuring earnings per share, both of which is a measure

of equity earnings.

Actual process is that the PE ratio of first ten companies are calculated individually and

then depending on the market share of each company further the weight of each

company is calculated on the basis of percentage of these companies market share.

And then the industry average PE ratio is decided. When this industry PE ratio is

compared with the actual PE ratio of each company in order to decide whether the stock

is over prices or under prices.


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1.7RESEARCH PROPOSAL

1.7.1PROBLEM STATEMENT:-There are different methods for analyze an

equity share price and the inputs needed for each method is different. So each method

generates different intrinsic value of the equity share price and the problem is which

value to choose. In some cases the difference between price generated by different

method is slightly varied in other cases price variation is wide so the problem is whether

to take an average value or to ignore the value which widely different form other

methods and to arrive at the right value.

1.7.2OBJECTIVES:-

1. To analyze the parameters to evaluate or value an equity share price.

2. To compare the value of the firm with that of market value of share.

3. To find a fair intrinsic value of the company using different methods.

1.7.3SCOPE OF STUDY:-

It is essential that strategic decisions for companies are based on accurate information.

Whether while buying, selling, merging, restructuring or raising additional capital, it is

imperative to know the value of a company. Accurate valuation helps in making prudent

investments and strategic decisions. Valuations are critical components of nearly allfinancial transactions. The demand of corporations and industrial practitioners to

optimize value for commercial purposes has driven the need to utilize valuation as a

strategic corporate tool. Valuation or the estimate of the current market value of an

asset is found in all business and in all dimensions.


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CHAPTER 2

REVIEW OF LITERATURE


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2.1Literature review

Review of literature means examining and analyzing the various literatures available in

any field either for references purposes or for further research. Further research can be

done by identifying the areas which have not been studied and in turn undertaking

research to add value to the existing literature. For the purpose of literature review

various sources of information have been used. Sources include books, journals as well

as some literature papers.

2.1.1The valuation of cash flows forecasts: an empirical analysis

By: Steven n. Kaplan and Richard s.ruback

The study provides evidence that discount cash flow valuation methods provide reliable

estimates of market value. their median estimates of discounted cash flows for 51 highly

leveraged transactions (HLTS) are within 10 percent of the market values of the

completed transactions and perform at least as well as valuation approaches using

companies in similar industries and companies involved in similar transactions .the

stress on estimates rely on a number of ad hoc assumptions that should be able to

improve on. the research expect such improvements to bring the DCF valuations even

closer to the transaction values.

Three CAPM-based approaches are use to estimate discount rate corresponding to

firm-level, industry-level, and market-level measures of risk. All three methods perform

well compared to those using comparable transactions and companies. They

considered the most realistic assumptions; the industry- and market-based approaches

perform best.


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In the second part, the forecasted cash flows and transaction values are calculated

using discount rates and risk premia.the median implied market equity risk premium, theamount by which the return on the equity market exceeds the long-term Treasury bond

yield, equals 7.78 percent. This accords well with the historical risk premium by which

returns on the S&P 500 have exceeded Treasury bond returns. The relations between

the implied risk premia and both firm and industry betas are positive and marginally

significant. In contrast, there are no apparent relations between the implied risk premia

and either transaction value.


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restructuring (where the financing mix is set by the acquirer) and the possibility that

financial leverage can change quickly over time. Second, the connections between

corporate finance and valuation have become clearer as value is linked to a firmsactions. In particular, the excess return models link value directly to the quality of

investment decisions, whereas adjusted present value models make value a function of

financing choices. Third, the comforting conclusion is that all models lead to equivalent

values, with consistent assumptions, which should lead us to be suspicious of new

models that claim to be more sophisticated and yield more precise values than prior

iterations.

The challenges for valuation research in the future lie in the types of companies that we

are called upon to value. First, the shift of investments from developed markets to

emerging markets in Asia and Latin America has forced us to re-examine the

assumptions we make about value. In particular, the interrelationship between corporate

governance and value, and the question of how best to deal with the political and

economic risk endemic to emerging markets have emerged as key topics. Second, the

entry of young companies into public markets, often well before they have established

revenue and profit streams, requires us to turn our attention to estimation questions:

How best do we estimate the revenues and margins for a firm that has an interesting

product idea but no commercial products? How do we forecast the reinvestment needs

and estimate discount rates for such a firm? Third, with both emerging market and

young companies, we need to reassess our dependence on current financial statement

values as the basis for valuation. For firms in transition, in markets that are themselves

changing, we need to be able to allow for significant changes in fundamentals, be they

risk parameters, debt ratios and growth rats, over time. In short, we need dynamic

valuation models rather than the static ones that we offer as the default currently.

Fourth, as the emphasis has shifted from growth to excess returns as the driver of

value, the importance of tying corporate strategy to value has also increased. After all,

corporate strategy is all about creating new barriers to entry and augmenting or

preserving existing ones, and much work needs to be done at the intersection of

strategy and valuation. Understanding why a company earns excess returns in the first


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place and why those excess returns may come under assault is a pre-requisit for good

valuation. Finally, while the increase in computing power and easy access to statistical

tools has opened the door to more sophisticated variations in valuation, it has alsoincreased the potential for misuse of these tools. Research on how best to incorporate

statistical tools into the conventional task of valuing a business is needed. In particular,

is there a place for simulations in valuation and if so, what is it? How about scenario

analysis or neural networks? The good news is that there is a great deal of interesting

work left to be done in valuation. The bad news is that it will require a mix of

interdisciplinary skills including accounting, corporate strategy, statistics and corporate

finance for this research to have a significant impact.

2.1.3The Cost of Distress Survival, Truncation Risk and Valuation

Aswath Damodaran:Stern School of Business:-

Traditional valuation techniques- both DCF and relative - short change the effects of

financial distress on value. In most valuations, we ignore distress entirely and make

implicit assumptions that are often unrealistic about the consequences of a firm being

unable to meet its financial obligations. Even those valuations that purport to consider

the effect of distress do so incompletely. In this paper, they begin by considering how

distress is dealt with in traditional discounted cash flow models, and when these models

value distress correctly. Then they look at ways in which they can incorporate the

effects of distress into value in discounted cash flow models. At last they conclude by

looking at the effect of distress on relative valuations, and ways of incorporating its

effect into relative value.

In both discounted cash flow and relative valuation, they implicitly assume that the firms

that they are valuing are going concerns and that any financial distress that they are

exposed to is temporary. After all, a significant chunk of value in every discounted cash

flow valuation comes from the terminal value, usually well in the future. In this paper,


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they will argue that they tend to over value firms such as these in traditional valuation

models, largely because is difficult to capture fully the effect of such distress in the

expected cash flows and the discount rate. The degree to which traditional valuationmodels miss value distressed firms will vary, depending upon the care with which

expected cash flows are estimated, the ease with which these firms can access external

capital market and the consequences of distress. In this paper, they will begin by

looking at the underlying assumptions of discounted cash flow valuation.

Distressed firms, i.e., firms with negative earnings that are exposed to substantial

likelihood of failure, present a challenge to analysts valuing them because so much of

conventional valuation is built on the presumption that firms are going concerns. In this

paper, they have examined how both discounted cash flow and relative valuation deal

(sometimes partially and sometimes not at all) with distress. With discounted cash flow

valuation, they suggested four ways in which they can incorporate distress into value

simulations that allow for the possibility that a firm will have to be liquidated, modified

discounted cash flow models, where the expected cash flows and discount rates are

adjusted to reflect the likelihood of default, separate valuations of the firm as a going

concern and in distress and adjusted present value models. With relative valuation, they

can adjust the multiples for distress or use other distressed firms as the comparable

firms. at last this paper examine two issues that may come up when going from firm

value to equity value. The first relates to the shifting debt load at these firms, as the

terms of debt get renegotiated and debt sometimes becomes equity. The second comes

from the option characteristics exhibited by equity, especially in firms with significant

financial leverage and potential for bankruptcy.


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Second, corporations do not experience an enduring increase in q after they

internationalize. This paper finds that (a) valuations are not higher afterinternationalization and (b) valuations of firms that internationalize do not increase

relative to those of domestic firms (i.e., the relative q does not increase after

internationalization). Thus, although there are large cross firm differences in q, their

results are consistent with the view that these differences are not affected by

internationalization.

Third, in terms of the year-by-year dynamics, qrises before internationalization, but then

falls rapidly in the year after internationalization. They find that one year after

internationalization the qof international firms is not significantly higher than it was two

years (or even three years) before they internationalized. Furthermore, the relative

Tobin.s qof international firms (qdivided by the average qof domestic firms from the

same home country) follows the same pattern: rising in the year before

internationalization and during the internationalization year, but relinquishing these

increases by the year after internationalization.

Finally, in terms of the components ofq, a firm.s market capitalization tends to rise prior

to internationalization and remains high thereafter, while the firm.s assets increase

during internationalization as the firm expands. Thus, firms that internationalize expand

relative to domestic firms.


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CHAPTER 3

RESEARCH METHODOLOGY


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3.1RESEARCH METHODOLOGY

3.1.1TYPE OF RESEARCH

Type of research is Descriptive research, which is Quantitative in nature.

3.1.2SAMPLING TECHNIQUE

Technique use for selection of samples is simple random sampling technique.

3.1.3DATA COLLECTION

Secondary Data

Income statements of companies under studyBalance sheetsHistorical stock prices

3.1.4SOURCES OF DATA

The data relating to the study is taken from two databases namely prowess and capital

line plus.


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3.1.5DATA REQUIRED AND PERIOD OF STUDY

Financial statements of the ten information technology large cap stocks are considered

for a period of years from financial year 2001-2002 to 2006-07.And also the stock

monthly average price and nifty monthly average price for the same period is

considered.

3.1.6SAMPLE SIZE AND METHOD OF SELECTION:-

The Sample size considered for the research undertaken has a scope of one industry &

ten companies in the industry and the industry selected is randomly choose and the

companies in the

Industries are selected on the bases of market leader and market capitalization.

Industry Information technology( large cap)

S.NO Company

1.HCL Technologies

2.

I-Flex Solutions3.Infosys tech

4.mphasis ltd

5.patni computer

6.Polaris Software

7.Satyam Computer

8.TCS

9.Tech Mahindra

10.Wipro


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CHAPTER 4

ANALYSIS OF DATA AND

INTERPRETATION


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4.1ANALYSIS & INTERPRETATION

4.2FREE CASH FLOW TO EQUITY MODEL

4.2.1Infosys technology LTD.

Year 2005 2006 2007 2008 2009 2010 2011 2012 2013

Sa les 6,859.6 9,028.00 13,149.00 18535.7

3

26129.2

3

36833.

5

51923.

0

73194.3 103179.

7

EBIT 2,229.7 2,737.00 4,153.00 5519.69

9

7336.16 9750.3

9

12959.

1

17223.8 22891.9

4Tax -327 -337 -392 -

1857.93

-

2469.35

-3281.9 -4362.0 -

5797.53

-

7705.43

change

in WC

-

1163.88

-1448 -1749.19 -2286.44 -3223.12 -

4543.52

-

6404.86

-9028.73 -12727.5

cash

flow

738.90 952.00 2,011.81 1375.33

2

1643.69

3

1924.8

8

2192.2

2

2397.54

3

15186.5

1

Disc oun

t

Rate

0.86046

4

0.74039

8

0.6370

8

0.5481

8

0.47169

7

present

value

1183.42

4

1216.98

7

1226.3

1

1201.7

5

1130.91

3Tota l 5959.39

5

Terminal value:-

At 5% At 8% At 10%

Present value FCFF 5959.395 5959.395 5959.395

Terminal value 63865.67 87184.52

115234.4

Long term debt -0 -0 -0

value of eq uity 69,825.07 93,143.92 121,193.76


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tota l sha res 571,209,862.00 571,209,862.00 571,209,862.00

equity p er sha re(RS) 1222.40655 1630.643 2121.70292

Interpretation:-

The market price as on 19/3/2008, the stock price of Infosys technology is Rs.1342 and

the intrinsic value according to free cash flows in equity falls between 5% to 8%. So the

investor, who has an estimation of above 5% terminal growth rate, Can buy the stock

because the stock is under valued.

4.2.2HCL TECHNOLOGIES LTD

Year 2005 2006 2007 2008 2009 2010 2011 2012

Sa les 1,127.98 1,447.01 3,032.92 4887.3475 7875.633 12691.055 20450.79 32955.07 53

EBIT 666.57 344.53 344.98 409.23469 485.4572 575.87667 683.1373 810.3759 96

Tax -13.64 -9.86 -21.5 -137.7484 -163.405 -193.8401 -229.944 -272.773 -3

change

in WC 405.89 -54.92-

111.57 15.683257 25.27252 40.724972 65.62557 105.7512

cash

flow 1,058.82 279.75 211.91 287.16955 347.3248 422.76156 518.8189 643.3546 63

Disc ount

Ra te 0.8620548 0.743139 0.6406262 0.552255 0.476074

present

va lue 247.5559 258.1105 270.83213 286.5203 306.2844

Tota l 1369.3032


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Terminal value:-

At 5% At 8% At 10%

Present value FCFF

1369.3032 1369.3032 1369.3032

Terminal value

2759.6075 3794.2146

5058.5524

Long term debt -13.83 -13.83 -13.83

Value of equity4,115.08 5,149.69 6,414.03

Total shares171047856 171047856 171047856

Equity per share(RS)240.58 301.07 374.98427

Interpretation:-

The market price as on 19/3/2008, the stock price of HCL is Rs.255 and the intrinsic

value according to free cash flows in equity falls between 5% to 8%. So the investor,

who has an estimation of above 5% terminal growth rate, Can buy the stock because

the stock is under valued.


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4.2.3SATYAM COMPUTERS LTD

Year 2005 2006 2007 2008 2009 2010 2011 2012

Sa les 3,464.22 4,634.31 6,228.47 8394.966 11315.05 15250.849 20555.67 27705.7 37

EBIT 867.76 1,448.61 1,580.84 2001.968 2535.283 3210.6705 4065.978 5149.135 6

Tax -180.21 -199.72 -122.16 -673.863 -853.376 -1080.712 -1368.61 -1733.2 -2

change

in WC-

584.28 -719.77 -360.59 -1356.95 -1828.94 -2465.1169 -3322.58 -4478.29 -

cash

flow 103.27 529.12 1,098.09 -28.8398 -147.035 -335.1581 -625.207 -1062.36 43

Disc ountRate 0.860492 0.740446 0.637148 0.548261 0.471774

present

va lue -24.8164 -108.872 -213.5453 -342.777 -501.193

Tota l -1191.2

Terminal value:-

At 5% At 8% At 10%

Present value FCFF -1191.2 -1191.2 -1191.2

Terminal value

18201.4758 24850.34

32850.32

Long term debt -13.79 -13.79 -13.79

value of eq uity16,996.48 23,645.34 31,645.32

tota l sha res657,091,673.00 657,091,673.00 657,091,673.00

equity p er sha re(RS)258.662275 359.8485 481.5968


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Interpretation:-

The market price as on 19/3/2008, the stock price of SATYAM TECH. LTD. is Rs.390

and the intrinsic value according to free cash flows in equity falls between 8% to 10%.

So the investor, who has an estimation of above 8% terminal growth rate, Can buy the

stock because the stock is under valued.

4.2.4TECH MAHINDRA LTD

Year 2005 2006 2007 2008 2009 2010 2011 2012 20

Sa les 945.64 1,242.67 2,929.04 5376.485 9868.964 18115.27 33252.01 61036.69 112037

EBIT 111.46 262.11 167.83 301.7458 542.5163 975.4036 1753.703 3153.026 5668.90

Tax -14.22 -24.29 -70.47 -101.568 -182.611 -328.321 -590.296 -1061.31 -1908.1

change

in WC 10 19.43-

235.53 -333.839 -612.788 -1124.82 -2064.7 -3789.92 -6956.

cashflow 97.24 257.25

-138.17 -133.661 -252.883 -477.738 -901.291 -1698.2 3760.75

0.773601 0.598459 0.462968 0.358153 0.277067

present

va lue -103.4 -151.34 -221.177 -322.8 -470.515

Tota l -1269.23


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Terminal value:-

At 5% At 8% At 10%

Present value FCFF-1269.23 -1269.23 -1269.23

Terminal value

3,007.81 3,613.59 4,122.25

Long term debt -17.02 -17.02 -17.02

value of eq uity 69,825.07 93,143.92 121,193.76

tota l sha res116,155,423.00 116,155,423.00 116,155,423.00

equity p er sha re(RS)258.9473 311.0996 354.8911

Interpretation:-

The market price as on 19/3/2008, the stock price of TECH MAHINDRA LTD. is Rs.651

and the intrinsic value according to free cash flows in equity, is far below than the

prevailing market price. So the stock is highly over valued and the investor who owns

the stock is recommended to sell.


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4.2.5I-FLEX SOLUTIONS

Year 2005 2006 2007 2008 2009 2010 2011 2012 201

Sa les 902.86 1,153.82 1,552.34 2044.851 2693.621 3548.227 4673.974 6156.886 8110.28

EBIT 247.11 285.55 381.04 489.3082 628.3396 806.8751 1036.14 1330.547 1708.60

Tax -49.4 -46.21 -25.1 -164.701 -211.499 -271.594 -348.765 -447.862 -575.11

change

in WC -285.4-

150.95

-

366.79 -463.075 -609.995 -803.528 -1058.46 -1394.28 -1836.6

cash

flow

-

87.69 88.39 -10.85 -138.468 -193.154 -268.247 -371.088 -511.597 1133.4

Disc ountRa te 0.830035 0.688957 0.571859 0.474662 0.393986

present

va lue -114.933 -133.075 -153.399 -176.142 -201.562

Tota l -779.111


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Terminal value:-

At 5% At 8% At 10%

Present value FCFF -779.111 -779.111 -779.111

Terminal value2885.457 3579.249

4262.514

Long term debt -0 -0 -0

Value of equity2,106.35 2,800.14 3,483.40

Total shares81,377,678.00 81,377,678.00 81,377,678.00


Interpretation:-

The market price as on 19/3/2008, the stock price of I-FLEX SOLUTIONS. is Rs.925 and

the intrinsic value according to free cash flows in equity, is far below than the prevailing

market price. So the stock is highly over valued and the investor who owns the stock is

recommended to sell.


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4.2.6MPHASIS LTD

Year 2005 2006 2007 2008 2009 2010 2011 2012 2013

Sa les 247.77 380.67 602.14 858.1876 1223.114 1743.218 2484.486 3540.962 5046.683

EBIT 49.28 83.99 142.03 188.5202 250.2277 332.1339 440.85 585.1518 776.6874

Tax -0.89 -3.4 -12.53 -63.4559 -84.2267 -111.796 -148.39 -196.962 -261.433

change

in WC -21-

48.65 -97.56 -61.3138 -87.3863 -124.545 -177.506 -252.987 -360.564

cash

flow 27.39 31.94 31.94 63.75045 78.61484 95.79216 114.9541 135.2032 515.2544

Disc ountRate 0.852425 0.726628 0.619396 0.527988 0.45007

present

value 54.34247 57.12375 59.33326 60.69441 60.85095

Tota l 292.3448

Terminal value:-

At 5% At 8% At 10%


Terminal value

1883.473 2490.236

3171.335

Long term debt -1.31 -1.31 -1.31

Value of equity2,174.51 2,781.27 3,462.37

Total shares162,406,981.00 162,406,981.00 162,406,981.00



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Interpretation:-

The market price as on 19/3/2008, the stock price of MPHASIS LTD is Rs.165 and the

intrinsic value according to free cash flows in equity falls between 5% to 8%. So the

investor, who has an estimation of above 5% terminal growth rate, Can buy the stock

because the stock is under valued.

4.2.7PATNI COMPUTERS

Year 2005 2006 2007 2008 2009 2010 2011 2012 20

Sa les 702.07 875.6 997.83 1219.547 1490.53 1821.726 2226.512 2721.242 3325.9

EBIT 256.40 248.33 314.77 355.5739 401.6673 453.7357 512.5539 578.9967 654.052

Tax -23.81 -53.29 -102.9 -119.686 -135.201 -152.727 -172.526 -194.89 -220.1

change

in WC -190.5 -413.8 575.56 -62.587 -76.4938 -93.4906 -114.264 -139.654 -170.6

cash

flow 42.08

-

218.7 787.39 173.3008 189.9723 207.5176 225.764 244.4527 433.89

Disc ount

Ra te 0.830051 0.688985 0.571893 0.4747 0.394026present

va lue 143.8485 130.8881 118.6778 107.1702 96.32061

Tota l 596.9053


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Terminal value:-

At 5% At 8% At 10%


Terminal value

1104.831 1370.532

1632.222

Long term debt -3.06 -3.06 -3.06

value of equity

1,698.68 1,964.38 2,226.07

total shares138,791,309.00 138,791,309.00 138,791,309.00

equity per share(RS)122.3907 141.5346 160.3895

Interpretation:-

The market price as on 19/3/2008, the stock price ofPATNI COMPUTERS. is Rs.207 and





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Interpretation:-

The market price as on 19/3/2008, the stock price ofPOLARIS SOFTWARE. is Rs.73 and




4.2.9WIPRO LTD

Year 2005 2006 2007 2008 2009 2010 2011 2012

Sa les 7,276.18 10,264.09 11,745.26 15288.22 19899.92 25902.74 33716.31 43886.85 57

EBIT 1,761.75 2,342.81 3,183.40 4102.953 5288.127 6815.648 8784.407 11321.86 14

Tax -261.06 -312.92 -334.1 -1381.05 -1779.98 -2294.15 -2956.83 -3810.94 -4

change

in WC -595.13 -323.74 -504.2 -566.047 -736.795 -959.05 -1248.35 -1624.91 -

cash

flow 905.56 1,706.15 2,345.10 2155.852 2771.348 3562.451 4579.228 5886.01 96

0.78513 0.616429 0.483976 0.379984 0.298337present

value 1692.623 1708.338 1724.142 1740.034 1756.014

Tota l 8621.151


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Terminal value:-

At 5% At 8% At 10%

Present value FCFF

8621.151 8621.151 8621.151

Terminal value 12911.84 14911.86

16629.08

Long term debt -382.7 -382.7 -382.7

value of equity

21,150.29 23,150.31121,193.76

total shares1,439,802,322 1,439,802,322 1,439,802,322


Interpretation:-

The market price as on 19/3/2008, the stock price of WRIPO LTD. is Rs.377 and the

intrinsic value according to free cash flows in equity, is far below than the prevailing




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4.2.10TCS

Year 2005 2006 2007 2008 2009 2010 2011 2012

Sa les 8,051.11 11,236.01 14,942.09 20361.77 27747.24 37811.5 51526.2 70215.39 9

EBIT 2,122.58 3,078.84 4,174.11 6448.808 9963.112 15392.55 23780.78 36740.22 5

Tax -241 -342.66 -424.59 -2170.67 -3353.58 -5181.13 -8004.61 -12366.8 -

change

in WC -1830.4 -1070.09 -1463.93 -1570.95 -2140.75 -2917.23 -3975.34 -5417.24

cash

flow 51.18 1,666.09 2,285.59 2707.192 4468.78 7294.193 11800.83 18956.22 3

Disc ountRa te 0.869344 0.75576 0.657016 0.571173 0.496546

present

va lue 2353.483 3377.324 4792.399 6740.316 9412.634

Tota l 26676.16

Terminal value:-

At 5% At 8% At 10%

Present value FCFF

8621.151 8621.151 8621.151

Terminal value186434.4 266002.9

371786.3

Long term debt -506.75 -506.75 -506.75

value of equity212,603.78 292,172.31 397,955.69

total shares 978,610,498.00 978,610,498.00 978,610,498.00



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Interpretation:-

The market price as on 19/3/2008, the stock price of TCS. Is Rs.810 and the intrinsic

value according to free cash flows in equity, is far below than the prevailing market

price. So the stock is highly over valued and the investor who owns the stock is

recommended to sell. There is huge difference between the stock price and the intrinsic

value so the possibility of information gap can be observed.


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4.3Dividend discount model:-

4.3.1INFOSYS TECHNOLOGY

INFOSYS 2003 2004 2005 2006 2007

RETENTION RATIO 0.8109 0.2388 0.8335 0.449 0.8226 0.63096

ROE 38.78 40.68 44.82 39.89 41.9 0.41214

GROWTH

0.260043

8

KS 0.138993

DO 649

STOCK

PRICE ----

Interpretation

One of the basic assumptions for Gordons dividend discount model is that the required

rate of return of equity must be greater than the sustainable growth rate of dividend. As

this condition is not satisfactory, for the Infosys technology Ltd. So the dividend

discount model can not be applicable in this case.


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4.3.2HCL TECHNOLOGIES

HCL

TECHNOLOGIES 2003 2004 2005 2006 2007

RETENTION

RATIO 0.6072 -0.28 -0.96 0.0866 0.1051 -0.08822

ROE 11.75 11.47 12.78 20.72 36.72 0.18688

GROWTH -0.01648655

KS 0.160111

DO 116.5

STOCK PRICE 648.259066

Interpretation

The stock price of HCL technologies as on 19/3/2008 is Rs.255 but the intrinsic value

according to dividend discount model is Rs 648 so, the HCL technologies share price is

under valued. So, more than 120% growth is expected in this stock.


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4.3.3SATYAM COMPUTERS LTD

SATYAM 2003 2004 2005 2006 2007

RETENTION

RATIO 0.8323 0.8109 0.7811 0.7651 0.6839 0.77466

ROE 28.14 26.85 25.88 23.57 20.55 0.24998

GROWTH 0.193649507

KS 0.16223

DO 232.41

STOCK

PRICE----------

Interpretation

One of the basic assumptions for Gordons dividend discount model is that the required

rate of return of equity must be greater than the sustainable growth rate of dividend. As

this condition is not satisfactory, for the SATYAM COMPUTERS Ltd. So the dividend

discount model can not be applicable in this case.


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4.3.4I-FLEX SOLUTIONS

I-FLEX

2003 2004 2005 2006 2007

RETENTION

RATIO 0.97 0.8375 0.8054 0.8483 0.9461 0.88146

ROE 19.06 19.36 18.9 19.72 26.77 0.20762

GROWTH 0.183008725

KS 0.204769

DO 10.4

STOCK

PRICE 565.401

Interpretation

The stock price of I-FLEX SOLUTIONS as on 19/3/2008 is Rs.925 but the intrinsic

value according to dividend discount model is Rs 565.401 so, the I-FLEX SOLUTIONS

share price is over valued.


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4.3.5MPHASIS LTD

MPHASIS

2003 2004 2005 2006 2007RETENTIONRATIO 0.4811 0.2983 0.2026 0.8816 0.9227 0.55726

ROE 20.07 13.99 10.93 13.58 7.25 0.13164

GROWTH 0.073357706

KS 0.173206

DO 9.82

STOCK

PRICE 105.5638739

Interpretation:-

The stock price of MPHASIS LTD as on 19/3/2008 is Rs.165 but the intrinsic value

according to dividend discount model is Rs 105 so, the MPHASIS LTD share price is

over valued.


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4.3.6PATNI COMPUTERS

PATNI 2003 2004 2005 2006 2007

RETENTION

RATIO 0.7925 0.818 0.89 0.9241 0.976 0.88012

ROE 9.69 11.49 21.08 21.54 23.47 0.17454

GROWTH 0.153616145

KS 0.217485

DO 41.48

STOCKPRICE 749.2227242

Interpretation:-

The stock price of PATNI COMPUTERS as on 19/3/2008 is Rs.207 but the intrinsic

value according to dividend discount model is Rs 750 so, the PATNI COMPUTERS

share price is highly under valued.


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4.3.7POLARIS SOFTWARE

POLARIS 2003 2004 2005 2006 2007

RETENTION

RATIO 0.71 -0.0604 0.6635 0.739 0.6726 0.54494

ROE 14.46 2.51 10.44 14.89 16.44 0.11748

GROWTH 0.064019551

KS 0.217477

DO 22.18


Interpretation:-

The stock price of POLARIS SOFTWARE as on 19/3/2008 is Rs.73 but the intrinsic

value according to dividend discount model is Rs 154 so, the PATNI COMPUTERS

share price is highly under valued


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4.3.8WIPRO TECHNOLOGIES LTD

Wipro 2003 2004 2005 2006 2007

RETENTION

RATIO 0.6782 0.6288 0.7566 0.1852 0.9713 0.64402

ROE 36.12 35.72 35.59 26.76 27.74 0.32386

GROWTH 0.208572317

KS 0.276744

DO 873.7


Interpretation:-

The stock price of WIPRO TECHNOLOGIES as on 19/3/2008 is Rs.377 but the intrinsic

value according to dividend discount model is Rs 15,490 so, the WIPRO

TECHNOLOGIES share price is highly under valued. But there is a vary large difference

between the market share price and intrinsic value. So this difference may because of

growth rate in dividends about 400 to 500% .as we know that dividend discount model is

best for stable growth firms this intrinsic price may not be acceptable.


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4.3.9TCS

TCS

2003 2004 2005 2006 2007

RETENTION

RATIO 0.451 0.5612 0.456 0.7651 0.6839 0.381

ROE 24.01 20.34 25.88 23.57 20.55 0.14

GROWTH 0.05334

KS 0.152787

DO 660.4

STOCK

PRICE 6994.939375

Interpretation:-

The stock price of TCS as on 19/3/2008 is Rs.810 but the intrinsic value according to

dividend discount model is Rs 6,995 so, the TCS share price is highly under valued. But

there is a vary large difference between the market share price and intrinsic value. So

this difference may because of growth rate in dividends about 400 to 500% .as we know

that dividend discount model is best for stable growth firms this intrinsic price may not

be acceptable.


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4.3.10TECH MAHINDRA

TECH

MAHINDRA 2003 2004 2005 2006 2007RETENTIONRATIO 0 0.6288 0.7566 0.1852 0.9713 0.50838

ROE 0 35.72 35.59 26.76 27.74 0.25162

GROWTH 0.127918576

KS 0.304978

DO 26.62


Interpretation

The stock price of TECH MAHINDRA as on 19/3/2008 is Rs.652 but the intrinsic value

according to dividend discount model is Rs 170 so, the TECH MAHINDRA share price

is highly over valued.


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4.4PE MULTIPLIER MODEL

Company

Price on

19/3/08 EPS P/E

MARKET

CAP WEIGHT

WEIGHTED

P/E VALUE

HCL TECHNOLOGIES 255 14.2 17.957 16,964.65 0.061277 1.100389 under value

I-FLEXSOLUATIONS 925 42.4 21.816 7,743.86 0.027971 0.610215 over value

INFOSYS 1,342.00 64.3 20.870 76,754.00 0.277237 5.786186 equal value

MPHASIS 165 5.9 27.966 3,442.89 0.012436 0.347780 over value

PATNI

COMPUTERS 207 27.6 7.5 2,879.39 0.0104 0.078003 under value

POLARIS

SOFTWARE 73 7.8 9.3589 722.68 0.00261 0.024430 under value

SATYAM 390 20.7 18.840 26,140.30 0.094419 1.778912 under value

TCS 810 36 22.5 79,266.60 0.286312 6.442027 over value

TECH

MAHINDRA 651 43.5 14.965 7,904.78 0.028552 0.427298 under value

WIPRO 377 18.6 20.268 55,034.44 0.198785 4.029144 under value

276,853.5 20.6243879

Interpretation:-

In PE multiplier mode the industrial PE ratio is calculated and whether the stock is under

valued or overvalued is decided by comparing the PE ratio of company with that of the

industry average.


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4.5RELATIVE COMPARISON OF COMPANIES:-

Company INFOSYS HCL I-FLEXMPHASI

S

POLARI

S TCS SATYAM

TECH

MAHIN

DRA WIPRO PATN

Revenue 13,530.0 3116.2 1365.86 1768.1 1041.7 14,942 6410.0 2,929 14047 266

ProfitMargin 45.03 44.7 46.13 32.5 31.6 43.4 40.11 34.2 28.9 35.6

Market Cap 76,754.0 16,964 7,743.8 3,442.8 722.68 79,266 26,140 7,904 55,034 2,87

Gross

margin - 1

yr 45.03 44.7 46.13 32.5 31.6 43.4 40.11 34.2 28.9 35.6

Grossmargin - 5

yr 46.71 59.31 64.01 40.54 32.45 45.2 42.67 - 38.62 37.

EBITD

margin - 1yr 35.15 26.55 28.19 17.08 16.46 33.4 27.47 21.4 25.75 23.1

EBITDmargin - 5yr 35.88 39.28 31.49 21.08 16.1 34.1 28.86 - 25.73 24.6

OperatingMargin -

1yr 31.58 21.98 24.5 5.82 11.8 32.4 25.38 18.2 23.14 19.9

Operating

Margin -5yr 31.46 26.96 28.9 5.26 11.02 31.9 25.21 - 22.86 20.

Sales - 1yr 13,149 3,032.9 1552.34 1760.6 1032.7 14,942 6228.4 2,929 13758 260

Sales - 5yr 37,420 7203 4861.91 4476.2 3719.7 32,410 18892 - 40527 786

debtors

turnover 6.9 6.09 3.99 4.82 5.64 7.83 5.1 7.57 6.05 2.0

fixed assets

turnover 3.91 2.77 2.25 5.48 2.44 5.45 3.9 4.34 6.86 1.8

RoA - 1yr 41 39 19 23 24

39 30 30 37 1

RoA - 5yr 46.8 23.4 23.4 17.6 19.8

23.4 29.8 29.8 36.6 2

RoE - 1yr 41.9 36.72 19.06 20.07 14.46

36.72 28.14 28.14 36.12 9.6

RoE - 5yr 41.214 18.69 20.76 13.16 11.75

18.688 25 24.98 32.39 17.4

RoCE - 1yr 45.99 12.89 20.48 20.93 17.11 29.85 39.73 14.7


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