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Module 6

business ananlysis and valuation

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8 views

Module 6

business ananlysis and valuation

Uploaded by

f20221453
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Module 6:

Hurdle rate or
discount rate
• Introduction

• Cost of Debt, Equity and overall capital

• Risk Premium

• Beta
Risk Premium

What is Risk Premium


and what does it Risk Estimation
measure?

1. Risk aversion of investors


1. Economic prosperity
2. Market episodes
2. Riskiness of the securities

Survey
Historical Implied
Premium

1. Individual Investors Assume that market is


2. Portfolio Managers Estimation differences; correctly priced
1. Time period
1. Short vs. long
Challenges 2. Risk free security
1. May not be reasonable choice
2. Volatile and may 3. Arithmetic and
change based on Geometric averages
condition
3. Short-term
Historical Premium

In other markets Country risk premium

Equity risk premium =Base premium for mature equity market+ Country premium

Country bond Default spread +


Relative SD Relative SD
default spread
Beta

Historical Beta Fundamental Beta Bottom up Beta Accounting Beta

1. Length of the period 1. Types of Business 1. Identification of 1. Biased downwards


2. Liquidity of the 2. Operating Leverage Business due to earning
asset 3. Financial Leverage 2. Estimate the smoothing
3. Choice of the Index unlevered beta of 2. Non-operating
similar firms factors
3. Estimate the UL beta 3. Less frequent
of the firm
4. Estimate D/E ratio
5. Calculate levered
beta
Step 1: Identify Business Segments:
1.Technology: 60% of revenue.
2.Retail: 40% of revenue.
Step 2: Find Industry Betas:
3.Technology industry beta = 1.4 (more volatile, higher risk).
4.Retail industry beta = 0.8 (less volatile, lower risk).
Step 3: Calculate Unlevered Betas:
5.Assume companies in both industries have similar debt levels.
6.Technology unlevered beta = 1.2 (after removing the effect of leverage).
7.Retail unlevered beta = 0.7.
Step 4: Calculate the Weighted Unlevered Beta:
8.Weighted unlevered beta = (1.2×60%)+(0.7×40%) = 1.02.
Step 5: Debt to Equity Ratio:
9.Assume the company’s debt-to-equity ratio is 0.5, and the tax rate is 30%.
Step 6: Levered beta
10.Levered beta = 1.02×(1+(1−0.3)×0.5)
11.Levered beta = 1.02×1.35=1.381.02
So, the bottom-up beta for the company is 1.38, meaning it is more volatile than the
Q1. Suppose an Indian company issues a bond with a par value of €10,000, 8 years to
maturity, and a coupon rate of 12 percent paid annually. If the market price is 10600,
what is the yield to maturity of the bond?

Bond Price = Present value of future cash flow + Present value of Principle

or Multiplied by PVAF and PVF

Calculate the value at 9% (first trial)


Calculate the value at 10% (second trial)
Calculate the value at 11% (third trial)
Calculate the value at 12% (fourth trial)

YTM = YTM of above price + [( Higher Price – Current Market Price)/ (Higher Price – Lower
Price)]

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