Corporate Finance (BAFI1008)

Tutorial Week 4

Share Valuation
Reminder

 Mid-semester Test
• Open online between 4:00 PM - 8:30 PM on Friday of Week 5, 31
March 2023, Melbourne time. Students will have 60 minutes to
complete the test.
• Once you start the test, you must complete it. You will have only one
attempt.
• 20 marks, accounting for 20% of the total grade for this course.
• Topics covered: Week 1 to Week 4.
• The test will consist of 20 questions (multiple choice + short-answer)
• Visit Canvas for Special Consideration / Extension information
Reminder

 Group Formation - Assessment Task 2

• 4 students per group
• Register your group on Canvas | People
• Email the 'Declaration of Group Work Commitment' statement
(available on Canvas) to the course coordinator by Friday 24 March
2023, 11:59 PM Melbourne time.
• Students who still do not have a group after this date will be randomly
assigned.
• Highly recommended that group members are in the same class.
Topic Summary
This week the key topics were
• Equities (part ownership of a business)
• Valuation of equities / shares
• Variable growth valuation
Bonds vs. Shares

Bonds (Debt) Shares (Equity)

Cost Interest expense Dividend payments

Periodic cash flows Fixed Variable

Maturity Fixed Term Infinite

Redemption Yes (at face value) No

Relative riskiness Low High

Share Valuation

• Shares have no maturity, therefore we assume that

dividends go on forever, like a perpetuity.

D1 D2 D3
𝑃𝑃𝑠𝑠 = + 2
+ 3
+⋅⋅⋅
1 + 𝑟𝑟 1 + 𝑟𝑟 1 + 𝑟𝑟
Constant Dividend Growth

 Zero growth (Perpetuity)

D D D
𝐷𝐷
𝑃𝑃𝑠𝑠 = 0 1 2 3 … etc. 
𝑟𝑟
 Constant growth (Growing Perpetuity)
𝐷𝐷1 D1 D2 = D1(1+g) D3 = D2(1+g)
𝑃𝑃𝑠𝑠 =
𝑟𝑟 − 𝑔𝑔 0 1 2 3 … etc. 

 𝑷𝑷𝒔𝒔 - share price

 𝑫𝑫𝟏𝟏 - dividend payment at the end of the first period
 𝒈𝒈 - dividend growth rate.
 𝒓𝒓 – required rate of return
Variable Growth Valuation

 Allow for different stages of growth

 More realistic

For instance: 2-stage growth

0 1 ……………….. n n+1 ………∞

g1 g2
Discussion Questions
Question 1
Yesterday, your company had just paid a semi-annual dividend of $1.35
per share and investors expected at that point in time that your company
would continue to pay this amount in dividends into the foreseeable future.
However, today your company announced at the general shareholder
meeting, that from now on the company expects that the dividends will
increase by 0.5% every half year. The investors in your company require a
yield of 7.6% p.a. for holding your shares.

(a) What was the share price of the shares in your company yesterday?
(b) What is the stock price today?
Question 1
Yesterday, your company had just paid a semi-annual dividend of $1.35
per share and investors expected at that point in time that your company
would continue to pay this amount in dividends into the foreseeable future.
However, today your company announced at the general shareholder
meeting, that from now on the company expects that the dividends will
increase by 0.5% every half year. The investors in your company require a
yield of 7.6% p.a. for holding your shares.

(a) What was the share price of the shares in your company yesterday?
(b) What is the stock price today?
Effective interest rate: Quarterly  Annual
• If the nominal annual rate is 8% p.a., compounded quarterly:
• We take the rate that is paid quarterly: 2%
• We convert to yearly:
• (𝟏𝟏 + 𝟎𝟎. 𝟎𝟎𝟎𝟎)𝟒𝟒 = 1.0824 → 8.24%

Required return: Annual  Quarterly

• If the required return by investors in a bond/share is 8% p.a.
• We can convert to quarterly:
• (𝟏𝟏 + 𝟎𝟎. 𝟎𝟎𝟎𝟎)𝟏𝟏/𝟒𝟒 = 1.0194 → 1.94%

Quick and dirty: Annual  Quarterly

𝟎𝟎.𝟎𝟎𝟎𝟎
• = 0.02 → 2.00%
𝟒𝟒

Required return: Quarterly  Annual

• If the formula tells us the return by investors in a bond/share is 1.94% per quarter.
• We can convert to yearly:
• (𝟏𝟏 + 𝟎𝟎. 𝟎𝟎𝟎𝟎𝟎𝟎𝟎𝟎)𝟒𝟒 = 1.0800 → 8%
Question 2
Today is 18th February 2022. Have a look at the dividend payments of Coca-Cola
Company over the past 5 years.
a) The value of a share depends on how much dividends the shareholder will
receive in the future. According to the Dividend Discount Model, the value of a
share should be equal to the PV of future dividends. One tool that shareholders
use to find out what dividends to expect from a share in the future from their
shares, is to look at the previous dividends.

Calculate Walt Disney’s total dividend payments per year, and use the yearly
dividend payments to calculate the average dividend growth rate over the past 5
years.
(a) Calculate Walt Disney’s total
dividend payments per year, and use
the yearly dividend payments to
calculate the average dividend growth
rate over the past 5 years.
(b) If you would have to estimate by
what rate the dividends of Disney will
grow on average in the future, what
would be your estimate?

It seems that Coca-Cola was able to

maintain a fairly stable dividend
growth

-> We could reasonably assume that

the 3.23% p.a growth rate will
continue

Predicted growth = Past growth =

3.23% pa.
c) Estimate what rate of return
investors require for holding Coca-
Cola’s shares using the Dividend
Discount model.
Question 3
Tribeca Global Natural Recourses limited has just paid an annual cash
dividend of $0.20 per share. Investors require a 16% return from
investments such as this. If the dividend is expected to grow at a steady
8% per year,
- what is the current value of a share?
- What will be the share worth in five years?
Question 4
Today is 31st December 2020. The forecasted dividend stream of the stocks of
Alterra Limited is:
AUD$
2021 (Div1) 2.40
2022 2.95
2023 3.80

Then 10% growth thereafter:

2024 4.18
2025 4.60 etc

a) What is the current share price, assuming that investors require a return of 17%
for investing in this stock?

$2.40 $2.95 $3.80 $4.18

…etc. 
T=0 1 2 3 4
Question 4
a) What is the current share price, assuming that investors require a return of 17%
for investing in this stock?

$2.40 $2.95 $3.80 $4.18

…etc. 
T=0 1 2 3 4
Question 4
b) What will be the share price one year from now?

$2.95 $3.80 $4.18

…etc. 
T=0 1 2 3

c) If you buy the stock today, and sell it one year from now, what will be your
dividend yield, and what will be your capital gains yield?

(d) What will be your total return during the first year? Comment on the
relationship that appears to exist here.
Question 5

Today is 22nd February 2022. Have a

look at the dividend payments of MGM
Resorts International over the past 5
years.

a) What could be the reason for the

sudden change in dividend payments
within this period?

The pandemic may have caused:

- loss of income for the company
- Increased uncertainty -> desire to hold
cash
Question 5

b) What was the average dividend

growth rate if we include 2020-2021?
And what if we exclude those years?
Question 5

c) If you would have to estimate by what

rate the dividends of MGM will grow on
average in the future, what would be
your estimate?

It might be reasonable to assume

that once the pandemic is over,
mGM could be able to go back to
their previous dividends
-> Predicted growth rate = 8.71%

(d) Estimate what rate of return

investors require for holding MGM’s
shares using the Dividend Discount
model.
Question 5

(e) Compare the dividend payments,

and the return that investors require
between stocks of Coca-Cola and
stocks of MGM. What do you see?