Chapter 16 - The Valutation Of Securities - Practical Issues

Question 1

What are some other scenarios where we can’t just use the dividend valuation model

Answer 1

1. Shares in an unquoted company so its harder to know what they are worth
2. Large holding of shares in a quoted company so if we have so much to have the majority then we will need to pay more than the market value

Question 2

What are some negatives with the dividend valuation model ?

Answer 2

1. Yes dividends do affect the price but they are not the only affect. We don’t have a perfect market
2. How do we estimate future dividends ? It’s what shareholders expect that determines the price. It is all based on estimates

Question 3

Alternative approaches to the dividend valuation model ?

Answer 3

As this model is based on estimates there are two other approaches

1. Net assets basis - on this basis the value per share is calculated as;

Value of net assets / number of shares

2. Earning basis - this approach uses price earnings ratio of a similar quoted company

PE ratio = Market value per share / Earning per share

Question 4

Ways to value the asset for net asset basis ?

Answer 4

1. If you use the book values as the non current assets, unless bought recently the book value has no relation to the actual value
2. Better idea is use the realisable value (how much can we get for the asset) then divide by the number of shares.

This therefore would be the minimum we would offer for a takeover as at least you could buy the company sell the assets and get your money back

3. Best option would be replacement value, if I’m making an offer to buy all the shares, how much would it cost start the company myself, this would be the maximum we would be prepared to pay (excluding the good will)

Question 5

How would you work out the PE ratio

Answer 5

Find the PE ratio for similar companies, for example if a similar company has a PE ratio of 15 and the current earning is 0.20c then the value of the share would be 15 x 20c = £3