BUSINESS FINANCE/ FINANCIAL MARKETS & INSTITUTIONS

[B Sc (Hons) in Management]

SEMINAR 3

EQUITY SECURITIES
1. Ordinary Shares • • Residual claimants Dual class shares

2. Preference shares • • • • Cumulative Participating Convertible Redeemable

3. Warrants

EQUITY SECURITIES
1. Values • • • • • Book Liquidation Market Price = PV (Cashflow) = PV (Dividends) + PV (Capital Gain/Loss) Dividend Discount Model • Without Growth/Constant Dividend Price0 = Div1/r

2. Valuation of Common Stocks

EQUITY SECURITIES
1. Valuation of Common Stocks • Dividend Discount Model • With Constant Growth Price0 = Div1/(r-g) = Div0(1+g)/(r-g) Determining “g”
• • Payout Ratio Ploughback Ratio

EXAMPLE 1
Castles in the Sand Ltd. generates a rate of return of 20% on its investments and maintains a plough back ratio of 0.3. Its earnings for the current year are expected to be $2 per share. Investors expect a 12% rate of return on the stock. Calculate the following for the firm : e) Price per share f) Price earnings ratio g) Dividend per share

EXAMPLE 2
Tiger plc has been paying out about 70% of its annual earnings in dividends, and it has been estimated that earnings per share next year are likely to be in the region of $8. Shareholders have earned a rate of return of 12% on their investments in recent years. As a result of industrial development in the vicinity of Tiger plc, some highly profitable investments are open to the firm in the short run. The Finance Director believes that it should be possible to invest 60% of the company’s earnings in each of the next 3 years in projects promising returns of 24%. It is most unlikely that projects yielding more than 12% will be available after the end of the 3rd year. It is expected that the company will then revert to paying out about 70% of earnings as dividends. REQUIRED : • Calculate the expected earnings & dividends per share in each of the next 4 years • What is the market value of Tiger’s share likely to be at the end of the 3rd year? • What is the current market price of Tiger’s share and how much of this is accounted for by the firm’s abnormal growth opportunities? • Calculate the prospective Price Earnings ratio (P/E) and state and comment on the main assumptions on which the model(s) employed in your analysis are based.

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