MGT201 GDB No. 1 Solution Spring 2022

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MGT201 GDB Solution Spring 2022

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Note: Last date of GDB submission is June 17, 2022.

Topic: “Valuation of Securities”

Scenario:

Investment decisions greatly depend upon valuation of investment options available in a stock market. Along with other market related factors, a rational investor relies on intrinsic value that truly depicts the value of a security based on its fundamental’s factors. The intrinsic value allows investors to take investment decision by identifying over-valued and under-valued securities. Considering the significance of intrinsic value, you are required to select the best option from the three available securities, keeping all other things constant.

Required:
Calculate intrinsic value of each above-mentioned security to identify whether the security is undervalued or overvalued (Formula and working is mandatory)
Based on intrinsic value, select one of the securities and justify your selection with proper reasoning.

Security 1: A bond issued forever with face value of Rs. 1,000 paying an annual coupon of 12%. The bond is currently selling at Rs. 980, whereas, the required rate of return for such securities is 15%.

SOL:

Calculation of Intrinsic Value of a Bond = ?
In our case this is perpetual bond because it is issued for infinite time period
Formula of calculation of Intrinsic Value of a perpetual Bond
V = Interest / Required Rate
Putting values in the formula
First of all calculate interest = 1000 x 12%
                                          = 1000 x 12 / 100
                                          = 120
V = Interest / Required Rate
V = 120 / 15%
V = 800
M.P > Intrinsic Value
Intrinsic value of a perpetual bond is overvalued.

Security 2: The preferred stock paying an annual dividend of 10% per share with a face value of Rs. 80 per share. The shares are currently selling at Rs. 75 per share, whereas, the required rate of return for such securities is 15%.

SOL2:
Calculation of Intrinsic Value of a Preferred Stock = ?
Formula of calculation of Intrinsic Value of a preferred stock
V= D/r
V= Dividend/Required rate
First of all calculate the value of dividend
Dividend = 80 X 10%
Dividend = 8
Putting values in equation
V = 8/15%
V = 53.33
M.P > Intrinsic value
Intrinsic value of preferred stock is overvalued.

Security 3: Common stock having face value of Rs. 100 per share. The company has paid Rs. 10 per share dividend last year and the annual growth rate of dividend is 5%. The shares are currently selling at Rs. 80 per share, whereas, the required rate of return for such securities is 15%.

SOL3:
Calculation of Intrinsic value of a common stock with constant growth = ?
Formula for calculation of intrinsic value of a common stock with constant growth
V = D1 / r-g
D1 = Next years dividend
D1 = ?
D1 = D0 (1+g)
 D1 = 10 (1+5%)
D1 = 10.5
Putting values in intrinsic value equation
V = D1 / r-g
V = 10.5 / 15% - 5%
V = 10.5 / 10%
V = 105
M.P < Intrinsic Value
So, Intrinsic value for common stock is undervalued.

According to calculations of three stocks we have concluded that result Intrinsic value of common stock is preferable.

1. When Intrinsic value < market price it is not profitable
2. When intrinsic value > market price it is profitable
3. It is greater than market price only in common stock case and it is undervalued.

So, common stock with constant growth is recommended.

MGT201 GDB Solution Spring 2022 PDF