Valuation of Securities

Valuation of Securities
Debentures/Bond

Value of Bond = Present Value of interest payment + present value of principal repayment at maturity

Example 1

A debenture has a face value of $1000.00,a coupon rate of 25% per annum ,a yield of 25% per annum and
a maturity of 15 years. What is the value of the bond?

Answer

= ×

$1000 × 25% = $250

1 − (1 + )
= +
(1 + )

1000 1 − (1 + 0.25)
= + 250
(1 + 0.25) 0.25

= $1000.00

Debenture Selling at a Premium

If the yield of a bond is less than the coupon rate of a bond ,the Price/Value of a bond will be more than
the Face Value of the Bond. The bond is said to be selling at a premium since the bond is paying more
interest than what is required by investor

Example 2

A debenture has a face value of $1000.00,a coupon rate of 25% per annum ,a yield of 20% per annum and
a maturity of 15 years. What is the value of the bond? Hence calculate the bond premium.

1000 1 − (1 + 0.20)
= + 250
(1 + 0.20) 0.20

$1233.77

= −

= $1233.77 − $1000 = $233.77

Think in monetary value terms T.M Sakuhuni 0775172625

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Valuation of Securities

Debenture Selling at a Discount

If the yield of a bond is more than the coupon rate of a bond ,the Price/Value of a bond will be less than
the Face Value of the Bond. The bond is said to be selling at a discount since the bond is paying less
interest than what is required by investor .

Example 3

A debenture has a face value of $1000.00,a coupon rate of 25% per annum ,a yield of 28% per annum and
a maturity of 15 years. What is the value of the bond? Hence calculate the bond discount.

1 − (1 + )
= +
(1 + )

1000 1 − (1 + 0.28)
= + 250
(1 + 0.28) 0.28

$895.60

= −

= $895.60 − $1000 = −$104.40

Class exercise

1.A bond has a Face value of $1000.00,a coupon rate of 18% per annum of which interest is paid on an
semi annually basis ,10 years to maturity and a yield of 20%. What is the value of the bond .Comment
whether the bond is selling at a premium or discount and justify.

2.A debenture has a face value of $100 ,a coupon rate of 25% per annum 15years to maturity and a yield
of 20% per annum. Calculate the value of the debenture and the debenture premium (3 marks)

Think in monetary value terms T.M Sakuhuni 0775172625

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Valuation of Securities

Irredeemable debentures
Companies sometimes issue debentures that are irredeemable .

An irredeemable debenture is therefore a perpetuity because interest will be paid by the debenture forever

where = the required rate of return

Example

An irredeemable debenture has a par value of $1000 and a coupon rate of 12% per annum. If the
required rate of return is 20% per annum. Determine the value of the bond.

= ×

$1000 × 12% = $120

$120.00
= = $60.00
0.2

Valuation of Preference Shares

where: is the value of preference shares

is the required return or yield of the preference share

is the dividend on the preference share

Example

A firm is about to issue preference shares with a par value of $100.00 and a coupon dividend rate 20%
per annum. If the required rate of return for such preference shares on the market is 25% per annum,
calculate the value of the share.

ℎ = 20% × $100.00

Think in monetary value terms T.M Sakuhuni 0775172625

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Valuation of Securities

= $20.00
$ .
ℎ = = $80.00
.

Valuation of common stock

Common stock valuation models usually assume that the shares will be held in perpetuity.

Given that shares are held forever it is usually simpler to forecast future dividends instead of the actual
dividends.

There are three basic models that are used to forecast the growth rate of future dividends : no-growth ,
constant growth and multiple growth

No-growth Model

The no-growth model assumes that dividend remain the same forever

Given that dividends remain the same forever this is a perpetuity.

The Value of the stock will be equal to dividend divided by the required rate of return

Example

An ordinary share is expected to pay a dividend of $15 forever and the required return on the stock is
15%. The value of the share will be:

$15
=
0.15

= $100

If the firm have 5000 shares the total value of the share will be equal to $500 000.

ℎ = ℎ × ℎ

Think in monetary value terms T.M Sakuhuni 0775172625

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Valuation of Securities

Constant Growth Model

Assumptions

 Dividends will grow at the same growth rate of growth forever

 Growth rate of the stock price is the same as the dividend growth rate
 The expected yield on dividends is constant
 The investment period is infinite
 The required rate on the investment or is greater than the growth rate in dividends

The Value of Common Stock will be:

where ℎ

is the next dividend or (1 + )

g is the dividend growth rate

= ×

where =

= ℎ

Example

A company has just paid a dividend of $175. The company has return on equity of 20% and reinvest
40% of its earnings. The required rate of return on the stock 15%.What is the value of the stock

= 0.2 × 0.4

= 8%

= (1 + )

= 175(1 + 0.08)

= $189

= . .
= $2700

Think in monetary value terms T.M Sakuhuni 0775172625

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Valuation of Securities

Multiple Growth model

There are two common situations of multiple growth

 where dividends grow at a super normal rate then grow at a constant growth
 Where dividends grow at a supernormal rate then no growth rate

In both cases, its required to divide the calculation into two parts.Calculate the present value of the
dividends during supernormal growth then add to the value in the constant or no growth

Example

A firm last paid a dividend of $120.The dividends are expected to grow by 40% per annum during the 3
year supernormal growth period when cost of equity is 30% . Thereafter they will grow at 20% per
annum and the cost of equity will be 25%.Calculate the value of the shares in the firm.

Supernormal growth Period up to year 3

Present value of the dividend

( . ) ( . ) ( . )
= + + = $418.00
( . ) ( . ) ( . )

= (1 + )

= 120(1 + 0.4) = $329

Constant Growth

= 329(1 + 0.2) = $395

Value of stock during constant growth = . .

= $ 7900

Present Value =
( . )
= $4045.00

Value of stock = PV of dividends in the supernormal growth + PV in the Constant growth

= $418 + $4045 = $4463.00

If dividends are not expected to grow after the supernormal growth :

Value of stock no growth period = = $ 1316.00

.

Present Value = ( . )
= $673.00

Value of stock = PV of dividends in the supernormal growth + PV in the no growth

Value of the Stock = $418 + $673 = $1092.00

Think in monetary value terms T.M Sakuhuni 0775172625
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Valuation of Securities

Exercise

A company has just paid a dividend of 200cents per share .The company has a return on equity
of 20% and reinvest 40% of its earnings .The required rate of return on the stock is
15%.Calculate the value of the stock?

If the company has 50 000 shares issued determine the total value of common stock?

Think in monetary value terms T.M Sakuhuni 0775172625

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