Valuation DDM

7/29/2019 Valuation DDM

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Valuation

DDM

Sageraj Bariya


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Valuing - Pure Theory example only

think* within the FACTs

There is a building with 4 floors (ground floor

parking only)

Each floor has 2 flats

Each flat can yield rent of Rs10,000 per monthfor rest of the life

Life of the building is 10years, post which it

would be demolished* Dont imagine what is not explicitly mentioned


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Theoretical value of building

No of Floors 4

No of room on each floor 2

Rent per month 10,000

No of month 12

Life of Building 10

Value (Rs) 96,00,000

Now state Practical Problems with thisapproach


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Practical

Would you buy building if I offered it to you

for Rs1cr?

Would you buy building if I offered it to you

for Rs50lac?


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Now Practical - Problems with

approach

What is the worth of Rs96lac in todays value?

Remember the concept of Principle & Interest

A = P x (1 + r)^ t

Where A Final amount, P =Principle , r = Rate of

Interest and t = time


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What is A?

If P = 10,000

R = 9%

T = 1

A = 10,000 X 9/100 x 1 = 900, i.e Rs10,900


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Similarly can you tell me what is P

If A = 20,000

R = 9%

T = 1

Solution 20,000 = P x (1 + 9/100)

P = 18,349

Apply this to our Building example and figurecurrent value of Rs96lac discounting at 9%


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Our case

In our case we have

yearly flow of Rs9.6lac9.6

+9.6

+9.6 . 9.6

(1+9%)^1 (1+9%)^2 (1+9%)^3 (1+9%)^10

Yrly flow (Rs) PV Rate Yr

9.6 9 9 1

9.6 8 9 2

9.6 7 9 3

9.6 7 9 4

9.6 6 9 5

9.6 6 9 6

9.6 5 9 7

9.6 5 9 89.6 4 9 9

9.6 4 9 10

96 62

Present worth of

Future Rs96lac


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Problem

Would you buy land for 50,000, construct for

300,000, if the house is expected to sell one

year down the line for 400,000? Disc rate =

10%.


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Solution

Total Construction Cost = 50,000 + 300,000 =Rs350,000

Discounting rate 10%

Meaning value of Rs350,000 one year hencewould be Rs385,000.

While sale value of house is Rs400,000, whichin todays PV is Rs363,636. while we are doing

it for much more cheaper Rs350,000 only. Yield on Investments = 14% (4/3.5-1) x 100


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A machine costs Rs 380,000 and produces

cash flows (in 000s) of

50,57,75,80,85,92,92,80,68,50 every year. If

the cost of capital is 12%, what is the NPV?


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solution

Cash inflow 12% Yr

50000.00 44,643 1.00

57000.00 45,440 2.00

75000.00 53,384 3.00

80000.00 50,841 4.00

85000.00 48,231 5.00

92000.00 46,610 6.00

92000.00 41,616 7.00

80000.00 32,311 8.00

68000.00 24,521 9.00

50000.00 16,099 10.00Total 4,03,696

Cash outflow 3,80,000


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What is the PV of the following perpetuities?

100,000 Rs at discount rate of 10%

Rs 350,000 @ discount rate of 17.5%

Rs 200,000 growing at 6% p.a. @ discount rate

of 12%


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Solution

1,00,000 3,50,000 20,000

10% 18% 12%

10,00,000 20,00,000 1,66,667


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How much would Rs 15,000 per annum

savings amount to at the end of 10 years if the

interest rate is 10%?


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yr amount R (%) A

1.00 15000.00 10% 16,500

2.00 15000.00 10% 18,150

3.00 15000.00 10% 19,965

4.00 15000.00 10% 21,9625.00 15000.00 10% 24,158

6.00 15000.00 10% 26,573

7.00 15000.00 10% 29,231

8.00 15000.00 10% 32,154

9.00 15000.00 10% 35,369

10.00 15000.00 10% 38,9061,50,000 2,62,968


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As a lucky draw winner, you have a range of

prizes to choose from:

Rs 100,000 today

Rs 180,000 at the end of 5 years Rs 11,400 a year forever

Rs 19,000 for 10 years

Rs 6,500 next year, increasing at 5% p.a. forever

Which one would you choose?


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Solution

Opportunity Cost - 9%

Cash in Hand 180k @5yrs 11,400 lifetime 19k@10yrs

6.5k forever

with 5% PA

1,00,000 1,80,000 11,400 19,000 6500.00

1,16,988 1,26,667 17,431 1.00 1,62,500

15,992 2.0014,671 3.00

13,460 4.00

12,349 5.00

11,329 6.00

10,394 7.00

9,535 8.00

8,748 9.00

8,026 10.00

1,21,935


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Valuation - DDM

What cashflow does shareholder have in case of a Company?

Valuing Company = Valuing all the likely dividend over the life

time of the company

Dividend Discount Model Dividend is all the income

shareholder gets from company hence use. A procedure for valuing the price of a stock by using

predicted dividends and discounting them back to present

value. The idea is that if the value obtained from the DDM is

higher than what the shares are currently trading at, then the

stock is undervalued


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Formula for valuing Fixed dividend paying

company

Alternatively if you can forecast individualdividend for each year

Div

R%

Div 1+

Div 2+

Div 3 . Div n

(1+R%)^1 (1+R%)^2 (1+R%)^3 (1+R%)^N


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Can you value a company that pays fixeddividend of Rs2, discounting it at 10%

Rs20

Can you value a company that pays fixeddividend of Rs5, discounting it at 8%

Rs62.5

Can you value a company that pays fixeddividend of Rs3.5, discounting it at 12%

Rs29.2


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What if company grows?

Company is legal entity and is suppose to haveongoing life.

G refers to long time average / sustainablegrowth meaning average out volatile early highgrowth phase then slow.

Remember Product Life Cycle Concept?

Div 1

(R-G%)


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Problem

Zen Ltd declared dividend of Rs10 per share

last year, which is likely to increase by 5% in

next year. Determine share price if Cost of

Equity is 15%.


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Solution

= 10x(1+5%) / (15%-5%)

= 10.5/10%

= Rs105


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What if

Companys usually dont follow linear growth

pathwhat to do in that case?


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How long period.?

2-Stage DDM

Explicitly forecast dividend for few years and

then use last formula

Div 1

+

Div 2

+

Div 3

. {(Div n)/(R% -G%)}

(1+R%)^1 (1+R%)^2 (1+R%)^3 (1+R%)^N


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Problem

If RIL is expected to pay the following

dividends, and then grow indefinitely at 4.5%

(assuming a discount rate of 14.50%), what

would its stock value be? 1.25, 2.75, 1.5, 2.8, 3.2


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solution

First we consider the price of the stock at time

five (at end of 5th year).

P D g

k gs

5

5 1 320 1 00450145 0045

3344010

44

. ( . ). .

..

$33.

Dividend in 5th yr is Rs3.2 & is likely to grow by 4.5% indefinitely


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0 1 2 3 4 5

$1.25 $2.75 $1.50 $2.80 $36.64

14.5%

$ 1.09

$ 2.10

$ 1.00

$ 1.63

$18.62

$24.44 = Present Value

(33.44 + 3.2) /

(1+14.5)^5


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Year Div R G PV Year Div R G PV

1 1.25 14.50% 1.09 1 1.25 14.50% 1.09

2 2.75 14.50% 2.10 2 2.75 14.50% 2.10

3 1.50 14.50% 1.00 3 1.50 14.50% 1.00

4 2.80 14.50% 1.63 4 2.80 14.50% 1.63

5 3.20 14.50% 1.63 5 3.20 14.50% 1.63

3.34 33.44 4.50% 18.62 3.34 33.44 4.50% 16.99

24.44 24.443.34/(14.5%-4.5%)

(3.2+33.44)/(1+14.5%)^5

33.44/(1+14.5%)^5

1.09+2.10+1.00+1

.63+18.62 1.09+2.10+1.00+1.63

+1.63+18.62


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Problem

A companys likely dividend over next 4 yrs as

followed

Yr-1 = Rs0.75, Yr-2 = 1.5, Yr-3=1.5, Yr-4 = 2 and

is likely to grow at CAGR of 5% there afterindefinitely.

Assume R 14%, arrive fair value of the Stock


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Solution Rs17.22

Year Div R G PV

1 0.8 14.00% 0.66

2 1.5 14.00% 1.15

3 1.5 14.00% 1.01

4 2.0 14.00% 1.18

5 2.10 14.00% 5.00% 1.09

Terminal Value at the end of 5th yr 23.33 12.12

17.22


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Problem

D P S 2

R 16%

Growth 0% to 10%


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Now you know why stock prices

changes everyday

12.5 13.314.3 15.4

16.718.2 20.0

22.225.0

28.6

33.3

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%

Stock Value


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Value your company on DDM basis

Take dividend amount

Take discount & growth rate as you think is fit

Documents

Valuation DDM