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II. Assignment two (THA#4, page 191) Valuation of Colgate Palmolive (I) Ltd. Stock using Dividend
Growth Model :
CAPM calculation is also attached.
We are ignoring CAPM, based upon weekly 5 years prices in comparison to S&P CNX NIFTY, as there,
market risk premium is coming negative. So, S&P CNX NIFTY may not truly represent a market
portfolio. (In case you have found it out, why don’t you adjust the Expected Rate of Return on
Market to a More Realistic number???? That would be more rational I guess and would solve the
problem you are facing.
In case I am estimating about the Indian markets.....I see that rf as offered by T bills is around 7%pa
and the bonds and other debt instruments provide a rate of return of up to 12% pa. Therefore I
would expect for the market index rate of return to be at least 15% or more before I would think of
investing in the market index.This implies that as per my expectations the market risk premium
should at least be 8% per annum. If you agree with this logic you would think of revising your
estimates accordingly (but that you should do only after finding the CAPM estimates and arguing for
the reasons of revising it). You may also use a similar logic and argument for revising your estimated
CAPM r either on the daily or the weekly basis. On the weekly basis the 8% pa market risk premium
would become (1+0.08)^(1/52)-1 (you can do similar calculation for the daily revised market risk
premium).
Therefore the Market rate of return can also be revised to a weekly basis by (1+0.15)^(1/52)-1 or a
daily basis.
So, taking CAPM calculation, based upon daily prices for year 2012, where market portfolio is S&P
CNX NIFTY , we are getting expected annual return as 11.05%. (but even in case of daily returns your
market risk premium seems to be negative....so how does it make a difference???)
Data on Colgate Palmolive financial parameters from websites are as under :-
Net Profit
(Cr)
Dividend
Payout (Cr)
RE
Retention
Ratio
Outstanding
Shares (Cr)
Dividend/
Share (Rs.)
2007-08 231.71 227.64 4.07 0.01756506 13.5993 16.739097
2008-09 290.22 238.13 52.09 0.17948453 13.5993 17.51046
2009-10 423.26 317.83 105.43 0.24909039 13.5993 23.371056
2010-11 402.58 348.87 53.71 0.13341448 13.5993 25.653526
2011-12 446.47 395.13 51.34 0.11499093 13.5993 29.055172
Avg 0.13890908

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Net Worth ROE
Traded price on
31st March
closing
Dividend Yield
Dividend
Growth
Rate
2007-08 231.71 162.21 1.4285 342.84
2008-09 290.22 216.3 1.3417 411.86 0.051074729 0.0460815
2009-10 423.26 326.11 1.2979 628.06 0.056745146 0.3346911
2010-11 402.58 384.05 1.0482 792.43 0.040845662 0.0976623
2011-12 446.47 435.39 1.0254 1101.48 0.036665916 0.1325995
Avg 1.2284 0.046332863 0.1839
A) We take g = 0.1839 as per hurdle rate of growth in dividend for last four years.
Then R is assumed to be as per CAPM, then R < g, and so it gets absurd.
You may take the assumption as above. But I would prefer to estimate g which is based on the
expected rate of return from equity reinvestment (it assumes that if you retain earnings, the
retained earnings becomes equity investment on which equity investors would require similar return
which they have been expecting on the actual equity i.e. CAPM estimated rate of return for
assuming the systematic risk in the company). Therefore taking the average retention rate as the
input and CAPM expected r (which you have estimated from the daily returns and have annualized) I
may estimate g as
g = 0.13890908 x 0.1105 = 0.01534945334 or aprox 1.54%
now using this I can calculate the Year 1 dividend on the time from the dividend of Year 2011-12
(assuming 2011-12 to be year zero on the time line) as D
1
= 29.055172*1.0154 = 29.5026216488.
Now using the DDM with growth formula V
0
= D
1
/(r-g) we can calculate V
0
=
29.5026216488/(0.1105-0.0154) = 310.22735698002103049421661409043
B-
C) If we calculate g = Retention Ratio x ROE (CAPM) = 0.1389 X .1105 = 0.0153
I am really getting confused as what kind of calculation to be used and basically I am finding it very
difficult to relate to practical the theory read from book or in classes.
Also, which CAPM to be used ? That is also a tough decision ? What is the practicality of these theory
?
Kindly help out.
You identified it right. There seems to be a lot of confusion and a closer looks into the theory is the
way out. First of all please understand that is a subject of logic and not an outcome of computation.
So have a reason as to which one would follow logically, rather than trying to somehow match it to
the current prices. If your logic is correct for choosing the path of valuation which cannot be
improved upon, it can have two reasons,

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 II. Assignment two (THA#4, page 191) Valuation of Colgate Palmolive (I) Ltd. Stock using Dividend Growth Model : CAPM calculation is also attached. We are ignoring CAPM, based upon weekly 5 years prices in comparison to S&P CNX NIFTY, as there, market risk premium is coming negative. So, S&P CNX NIFTY may not truly represent a market portfolio. (In case you have found it out, why don’t you adjust the Expected Rate of Return on Market to a More Realistic number???? That would be more rational I guess and would solve the problem you are facing. In case I am estimating about the Indian markets.....I see that rf as offered by T bills is around 7%pa and the bonds and other debt instruments provide a rate of return of up to 12% pa. Therefore I would expect for the market index rate of return to be at least 15% or more before I would think of investing in the market index.This implies ...
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