Managerial

Finance FIN300
Fall 2021

Finance Department
Chapter 8 Valuation of Shares and Companies

Reference in textbook
pp. 210-211; 212-216
 Outline
• Legal Rights and Privileges of Ordinary
Shareholders
• Types of Ordinary Shares
• Valuing Ordinary Shares
• Valuing a Share Using the Growth Model
 1. Legal Rights and Privileges of Ordinary
Shareholders
Control of the firm
• Firm’s ordinary shareholders have right to elect its directors.
• Elections of directors happen regularly, usually once a year.
• Directors elect officers who manage the company
• In a small company largest shareholders serve as president and chairperson
of the board.
• Each share has one vote, so the owner of 10 shares will have 10 votes.
• Voting: Shareholders can appear at the annual meeting or use proxy
• A proxy fight is the action of a group of shareholders joining forces, in a bid
to gather enough shareholder proxies to win a corporate vote.
 1. Legal Rights and Privileges of Ordinary
Shareholders
The Pre-emptive right
• Preemptive rights are a contractual clause giving a shareholder the
right to buy additional shares in any future issue, before the shares are
available to the general public.
 2. Types of Ordinary Shares
• Most firms have one type of ordinary share.
• When firms use more than one type, they are usually designated as
Type A, Type B and so on…
• Some types have voting rights and others don’t.
• The share with voting rights is usually more valuable.
• The gap in value between these types of shares depends on the legal
system of the country that is with fairly strong protection for minority
shareholders.
• What are tracking shares? (companies with multiple lines of business)
 3. Valuing Ordinary Shares
3.1 Definition of Terms
• 𝐷𝑡 is the dividend that the shareholder expects to receive at
the end of year t. 𝐷0 is the most recent dividend which has
already been paid. It is known with certainty. 𝐷1 is the first
cash flow received. Future dividends are expected values.
• 𝑃𝑡 is the share price at the end period t. 𝑃0 is the is the actual
market price of the share today. Future prices are expected
values and assume that dividends are already paid.
• 𝐸 𝑃0 is the estimated value of the share today as seen by the
particular investor. It is likely to differ from 𝑃0 .
• 𝐷1 Τ𝑃0 is the expected dividend yield during the coming year
 3. Valuing Ordinary Shares
3.1 Definition of Terms
𝑃1 −𝑃0
• = expected capital gains yield during the coming year.
𝑃0
• 𝑔 is the expected growth rate of dividends as predicted by an investor
who is prepared to buy or sell at the current price.
• 𝑟𝑠 is the required rate of return on the share. We can determine it using
the CAPM model.
• 𝐸 𝑟𝑠 is the expected rate of return that an investor who buys the share
𝐷1 𝑃1 −𝑃0 𝐷1
expects to receive in the future: 𝐸 𝑟𝑠 = + = +𝑔
𝑃0 𝑃0 𝑃0
• 𝑟𝑠𝑎 is the actual or realized after-the-fact rate of return
 3. Valuing Ordinary Shares
3.2 Expected Dividends
• The value of a share can be modelled as the present value of expected
future cash flows. For a simple regular dividend-paying share held
indefinitely:
𝐷1 𝐷2 𝐷3 𝐷∞
𝑃0 = 1
+ 2
+ 3
+ ⋯+
1 + 𝑟𝑠 1 + 𝑟𝑠 1 + 𝑟𝑠 1 + 𝑟𝑠 ∞
∞
𝐷𝑡
𝑃0 = ෍ 𝑡
1 + 𝑟𝑠
𝑡=1
 4. Valuing a Share Using the Growth
Model
• Since dividend value grows with inflation, it is wrong to assume that dividends are
estimated as constant. The growth model is written in the following way:

𝐷1 𝐷2 𝐷3 𝐷∞
𝑃0 = 1
+ 2
+ 3
+ ⋯+ ∞
1 + 𝑟𝑠 1 + 𝑟𝑠 1 + 𝑟𝑠 1 + 𝑟𝑠

𝐷0 1 + 𝑔 1 𝐷0 1 + 𝑔 2 𝐷0 1 + 𝑔 3 𝐷0 1 + 𝑔 ∞
𝑃0 = + + + ⋯+
1 + 𝑟𝑠 1 1 + 𝑟𝑠 2 1 + 𝑟𝑠 3 1 + 𝑟𝑠 ∞
∞
𝑡
𝐷0 1 + 𝑔 𝐷1
𝑃0 = ෍ 𝑡
=
1 + 𝑟𝑠 𝑟𝑠 − 𝑔
𝑡=1
𝑃1 −𝑃0
Note that 𝑔 =
𝑃0
 Applications
• Problems 8-1; 8-8; 8-9; 8-16; 8-27
Problem 1
Problem 2
Problem 3
Problem 4
Problem 6