Financial Management Share Valuation.pptx

Valuation of Security

1. Financial Management

2. Valuation of Shares A company may issue two types of shares: Ordinary shares and Preference shares Features of Preference and Ordinary Shares Claims  Dividend  Redemption

3. Valuation of Preference Shares The value of the preference share would be the sum of the present values of dividends and the redemption value. A formula similar to the valuation of bond can be used to value preference shares with a maturity period:

4. Valuation of Preference Shares

5. Value of a Preference Share-Example

6. Valuing Irredeemable preference share Consider that a company has issued Rs 100 irredeemable preference shares on which it pays a dividend of Rs 9. Assume that this type of preference share is currently yielding a dividend of 11 per cent. What is the value of the preference share? The preference dividend of Rs 9 is a perpetuity. Therefore, the present value of the preference share is:

7. Valuation of Ordinary Shares The valuation of ordinary or equity shares is relatively more difficult. The rate of dividend on equity shares is not known ; also, the payment of equity dividend is discretionary . The earnings and dividends on equity shares are generally expected to grow, unlike the interest on bonds and preference dividend.

8. Dividend Discount Model (DDM) The value of a share today depends on cash inflows expected by investors and the risks associated with those cash inflows . Cash inflows expected from an equity share consist of dividends that the owner expects to receive while holding the share and the price, which he expects to obtain when the share is sold. The price, which the owner is expected to receive when he sells the share, will include the original investment plus a capital gain (or minus a capital loss).

9. Dividend Capitalisation The value of an ordinary share is determined by capitalising the future dividend stream at the opportunity cost of capital Single Period Valuation : If the share price is expected to grow at g per cent, then P 1 : We obtain a simple formula for the share valuation as follows:

10. By Simplifying, share valuation can

11. Numericals

12. A company’s expected dividend next year Rs 5 per share. The dividend is expected to grow at 8 per cent per annum for ever. The equity capitalization rate is 12 per cent. What should be the value of the company’s share?