# WEEK 6 - Valuation of Shares Flashcards

1
Q

What are the elements of Ordinary Shares?

A
• Represent equity share capital of the firm
• Part Owners of the firm
• Vote at shareholder meetings
• Right to receive share of dividends distributed
• Each shareholder entitled to copy of the annual report
• No agreement between ordinary shareholder and company that the investor will receive back the original capital invested
2
Q

What are the elements of holding debt? (i.e Company owes you)

A
• Usually the lenders to the firm have no official control
• Usually requires regular cash outlays in the form of interest and the repayment of the capital sum (firm will be obliged to maintain the repayment schedule through good years and bad)
3
Q

What are the disadvantages of Ordinary Shares for investors?

A
• Last in the queue to have their claims met
4
Q

What is the importance of a well run stock exchange?

A
• Firms can find funds and grow
• Allocation of capital
• Status and publicity
• Mergers
• Improves corporate behaviour
5
Q

How do we get the Dividend Valuation Model if we assume Dividends are constant? (Model to infinity)?

A

Simply via transforming the expected holding period return

Secondly, by finding each period’s answer

(SEE IN NOTES)

6
Q

What is the Dividend Valuation Model if we assume Dividends are constant? (Model to infinity)

A

P0 = D1 +P1 / (1+R) = D1/1+R + P1/1+R

SEE IN NOTES

7
Q

What is the calculation to the first Dividend Growth Model?

A

d1 = (1+g)d0

• Assuming dividends grow at a constant rate of G

(SEE IN NOTES)

8
Q

How do you find the second dividend growth model?

A

By finding the sum of the geometric series of the first model

(SEE IN NOTES)

9
Q

What is the second dividend growth model?

A

P0 = d0(1+g)/r-g = d1/r-g

```Where:
p0 = Current Price
d1 = Future Dividend
r = Required rate of return
g = Growth rate of dividend ```

USE THIS ONE

10
Q

EXAMPLES OF SECOND DIVIDEND GROWTH MODEL

A

SEE PRACTISE Q IN NOTES

AND SEE PEARSON PLC IN NOTES

11
Q

What is the required rate of return based on the second dividend growth model?

A

r = d1/po +g

12
Q

How do we calculate Non-constant growth?

A

Step 1: Calculate dividends for super normal growth phase

Step 2: Calculate Share Price at time 3 when the dividend growth rate shifts to new permanent rate

Step 3: Discount and Sum the amount calculated in Stages 1 and 2

EXAMPLE OF NORUCE PLC IN NOTES

13
Q

What are the issues with the Divdend Growth Model?

A
• Companies that do not pay dividends

There are problems with the dividend valuation models i.e.

1. Highly sensitive to the assumptions
2. The quality of input data often poor
3. If G exceeds R a nonsensical result occurs
14
Q

How can we forecast the dividend growth rates (g)?

A

Determinants of Growth:

1. The quality of resources retained and reinvested within the business
2. Rate of return on existing assets
3. Rate of Return earned on existing assets

Growth - Focus on the firm:

1. Strategic analysis
2. Evaluation of Managment
3. Using historic growth rate of dividends
4. Financial statement evaluation and ratio analysis
• Growth - Focus on economy
15
Q

What are the downsides to using a comparison measure like the PER Model?

A
• Some analysts use PER (P0/E0) to make comparisons between firms
• Analysing through comparisons lacks intellectual rigour
(As it boldly assumes the ‘comparable’ companies are correctly priced)
• Fails to provide a framework for the analyst to test the important implicit input assumptions

SEE EXAMPLE OF RIDGE PLC IN NOTES

16
Q

How do you calculate the Dividend Yield?

A

D/P

17
Q

How do you calculate the Dividend Payout ratio?

A

dps/ E

Where:
dps is dividend per share
E is earnings per share

18
Q

How do you calculate the Dividend Cover?

A

E/dps

19
Q

What are the ways we can quantify the risk and likely return of an investment?

A

Could

• Use probabilities to attach numbers to the likelihood of each state of the world occurring
• Look at Historical prices
20
Q

How do we calculate expected return?

A

E(r) = p1r1 +p2r2 +p3r3+ Pnrn

SEE EXAMPLE IN NOTES

21
Q

What is the Standard Deviation?

A

Measure of the dispersion of outcomes around the expected value. Most common measure of risk used in theory of investment.

22
Q

What are the formulas used for Standard Deviation?

A

Standard Deviation = Square root of Variance

Variance = Sigma of (E(r) - ri) squared pi

SEE NOTES FOR CLEARER VIEW