VALUATION OF SECURITIES

1.0 Definition
The value of a security, Vs is the present value of expected future cash flows to be generated
from that security. For example, if an investor has invested in bonds, he is expecting annual
interest and receives dividends if he invests in shares or stocks.
The value of the security is computed as follows
n
CFt
Vs = ∑
t
(1+K)
t=1

Where CFt is the expected cash flow at time t, k is the appropriate discount rate, n is the total
number of years the investor will hold the security.
2.0 Valuation of Debt
2.1The valuation of debt – irredeemable debt
Irredeemable debt is debt that is never repaid. The holder of this debt will simply receive
interest each year for ever (unless they choose to sell it on the stock exchange, in which case
the purchase will continue to receive the interest).
Example 1
Papi plc has in issue TZS 50,000,000 10% irredeemable debentures. Investors currently require
a return of 8% p.a. What will be the market value of the debt?
Example 2
Quantico plc has in issue TZS100,000,000 6% irredeemable debentures. Investors currently
require a return of 12% p.a. What will be the market value of the debt?
2.2 The valuation of debt – redeemable debt
In practice, debt is not irredeemable but redeemable which means that the company will repay
the borrowing at some specified date in the future.
Example 3
Rombo Plc has in issue TZS 40,000,000 8% debentures redeemable in 5 years’ time at a
premium of 10%. Investors require a return of 12% p.a. Calculate the market value of the debt.
Logic: Present values of Cash-flows (Interest and Principal at Maturity)
Example 4
Semeni Plc has in issue $1,000,000 7% debentures redeemable in 4 years’ time at par. Investors
require a return of 10% p.a. Calculate the market value of the debt.
3.0 Valuation of preferred Stock
Logic: make Po the subject from the cost of the preferred formula

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 Dp
Therefore Vp = .
kp

Vp is the value of the preferred stock, Dp is the periodic preferred dividend and kp is the
discount rate or required return on preferred stock
Example 5
A firm has in issue 12% preference shares with a nominal value of TZS 100 each. Currently
the required return of preference shareholders is 14%. What is the value of a preference share?
4.0 The valuation of equity – constant dividends
4.1 The valuation of equity – constant dividends
The market value of a share is effectively determined by the shareholders – it is the price that
shareholders are prepared to pay for a share on the stock exchange.
In theory, the amount that shareholders are prepared to pay depends on two factors:
 The dividends that they expect to receive in the future
 The rate of return that shareholders require
Example 6
Alpha plc has in issue TZS 100 shares and has just paid a dividend of 20c per share. Dividends
are expected to remain constant. Shareholders required rate of return is 10% p.a. What will be
the current market value per share?
Logic: Remember the formula for cost of common stock, when dividends remain constant? Now
apply here but in this case find Po
De
Therefore Ve =
ke

Where….. refer to the above definitions of preferred stock, and change preferred stock to
common stock (equity)
Example 7
Beta plc has in issue TZS 50 shares and has just paid a dividend of 15c per share. Dividends
are expected to remain constant. Shareholders required rate of return is 12%. What will be the
current market value per share?
4.1.1 Cum-div / ex-div values
 In both the above examples, the company had just paid a dividend, and therefore anyone
buying the share would have to wait for a year until they were to receive their first
dividend (in the examination we ignore the possibility of interim dividends). We call
this situation an ‘ex-div’ valuation.
 Suppose, however, that the company was about to pay a dividend. This would mean
that someone buying the share would receive a dividend virtually immediately (in
addition to all the future dividends). Therefore the price that they will be prepared to

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 pay will be higher by the amount of the dividend about to be paid. We call this situation
a ‘cum-div’ valuation.
Market value cum-div = market value ex-div + dividend about to be paid
Example 8
Gamma plc has in issue TZS 50 shares and is about to pay a dividend of 15c per share.
Dividends are expected to remain constant. Shareholders required rate of return is 12%. What
will be the current market value per share?
4.2 The valuation of equity – non-constant dividends
The market value of a share is the present value of future expected dividends, discounted at the
shareholders required rate of return.
Logic: the same as from the start, we derive the value of equity form the cost of common stock
where there is growth.
Example 9
Gamma plc has just paid a dividend of 30c per share. Dividends are growing at the rate of 4%
p.a. The shareholders required rate of return is 15% p.a. Calculate the market value per share.
Example 10
Epsilon plc has just paid a dividend of 40c per share. Dividends are growing at the rate of 6%
p.a. The shareholders required rate of return is 20% p.a. Calculate the market value per share.
Test your understanding
Omega plc has just paid a dividend of 20c per share. It is intended that the dividend will remain
at 20c for each of the next 2 years and thereafter will grow at 4% per year. The shareholders
required rate of return is 15% p.a. Calculate the market value per share

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