Case 041DCF and intrinsic valueCore

Case presentation to a panel: Helvika Solar has a bear value of Rs 180 (30%), a base of Rs 300 (50%) and a bull of Rs 450 (20%), against a share price of Rs 320. State your view and the uncertainty around it.

The situation

Helvika Solar makes solar cells and modules. You have built three DCF scenarios. Bear, Rs 180 a share: overseas oversupply keeps module prices low and utilisation stays near 55%. Base, Rs 300: utilisation reaches 75% and margins hold at today's level. Bull, Rs 450: a new cell line ramps on time and policy support for domestic manufacturing lets Helvika earn a premium.

You weight them 30%, 50% and 20%. The shares trade at Rs 320. The panel has given you two weeks and fifteen minutes to present.

Your task

What is the probability-weighted value, how wide is the uncertainty, and what view do you present?

Quick check

Your weighted value is Rs 294 and the price is Rs 320. What is the most informative way to say this to the panel?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The probability-weighted value is Rs 294, about 8% below the Rs 320 price, so the upside case is already paid for. The price implies a 37% chance of the bull case against your 20%. The uncertainty is wide: one standard deviation is about Rs 94, a band of roughly Rs 200 to 388. The view to present: slightly above fair value with a skew you are not paid for, turning on whether the new cell line ramps on time.

Step 1How do you turn three scenarios into one number?

A farmer choosing a crop weighs a good monsoon, a normal one and a poor one by how often each happens. Weight each scenario value by its probability and add them: 0.30 times 180 plus 0.50 times 300 plus 0.20 times 450 is Rs 294. That is the expected valueThe average outcome if the same situation were repeated many times, found by weighting each outcome by its probability. of the share. It is below the base case because the bear case is both likely and severe.

The relationship
E[V]=0.30×180+0.50×300+0.20×450=294σ=∑pi(Vi−E[V])2≈94E[V] = 0.30 \times 180 + 0.50 \times 300 + 0.20 \times 450 = 294 \qquad \sigma = \sqrt{\textstyle\sum p_i (V_i - E[V])^2} \approx 94
E[V]probability-weighted value per share
p i, V iprobability and value of each scenario
sigmastandard deviation, how far outcomes typically sit from the weighted value
What it says in wordsThe weighted value is the average of the scenarios by probability, and the standard deviation measures how spread out they are around it.
Three scenarios, one weighted value, and where the price sits, Rs a share150200250300350400450Bear: Rs 180, 30% likelyBase: Rs 300, 50% likelyBull: Rs 450, 20% likelyWeighted Rs 294Price Rs 320Green strip: weighted value plus or minus one standard deviation, Rs 200 to 388
Helvika's bear, base and bull values of Rs 180, 300 and 450 weighted 30%, 50% and 20% give Rs 294, with a one standard deviation band of Rs 200 to 388; the Rs 320 price sits above the weighted value.
Step 2How wide is the uncertainty, and what does it do to the view?

The scenarios run from 44% below the price to 41% above it, and the standard deviation is about Rs 94, nearly a third of the value. A gap of Rs 26 between price and weighted value is small against a spread that wide, so the honest view is modest: slightly expensive, not a short. What matters more is the shape. The downside, Rs 140 to the bear case, is larger than the upside, Rs 130 to the bull case, and the bear case is more likely.

Step 3What does the price assume?

Hold the bear case at 30% and ask what bull probability makes the weighted value equal Rs 320. The answer is 37%, almost double your 20%: the market is treating the new cell line and policy support as far more likely than you do. That is the sentence to lead the presentation with, because it tells the panel exactly where you disagree with the price and what evidence would settle it: the cell line's commissioning date and first-quarter yields.

What the price implies: value against the bull-case probability260290320350Price Rs 320Your view: 20% bull, Rs 294Market's implied bull odds: 37%0%10%20%30%40%50%60%70%Probability given to the bull case (bear held at 30%)
Holding the bear case at 30%, Helvika's weighted value rises from Rs 294 at your 20% bull probability to the Rs 320 price only when the bull case is given 37%.

Close with what would change your mind. If the cell line commissions on time and yields reach plan, move the bull probability up and the view to fair. If module prices fall another leg, the bear case gets heavier. Say both; a panel marks the conditions as much as the verdict.

Where candidates lose it

The common loss is presenting the base case as the answer, Rs 300 against Rs 320 so roughly fair, and never weighting the scenarios. The bear case is likely and severe, and ignoring it overstates value by Rs 6 a share and hides the skew.

The second is presenting Rs 294 as precise. With a standard deviation of about Rs 94 the panel wants to hear the band and the probability the price implies, not a false decimal.

What the interviewer asks next

  • How would you justify the 30% probability on the bear case to a sceptical panel?
  • The bull case gets a new policy incentive. How do you update the weights rather than the values?
  • Why might a skewed distribution matter more to a portfolio manager than the weighted value?

Company names and figures are illustrative.