BUSINESS FINANCE/

FINANCIAL MARKETS & INSTITUTIONS

[B Sc (Hons) in Management]

SEMINAR 3
EQUITY SECURITIES

1. Ordinary Shares
• Residual claimants
• Dual class shares

2. Preference shares
• Cumulative
• Participating
• Convertible
• Redeemable

3. Warrants
EQUITY SECURITIES

1. Values
• Book
• Liquidation
• Market
2. Valuation of Common Stocks
• Price = PV (Cashflow)
= PV (Dividends) + PV (Capital Gain/Loss)
• Dividend Discount Model
• Without Growth/Constant Dividend
Price0 = Div1/r
EQUITY SECURITIES

1. Valuation of Common Stocks

• Dividend Discount Model
• With Constant Growth
Price0 = Div1/(r-g)
= Div0(1+g)/(r-g)

Determining “g”
• Payout Ratio
• Ploughback Ratio
EXAMPLE 1

Castles in the Sand Ltd. generates a rate of return of 20% on

its investments and maintains a plough back ratio of 0.3. Its
earnings for the current year are expected to be $2 per share.
Investors expect a 12% rate of return on the stock.

Calculate the following for the firm :

e) Price per share

f) Price earnings ratio
g) Dividend per share
EXAMPLE 2

Tiger plc has been paying out about 70% of its annual earnings in dividends, and it has
been estimated that earnings per share next year are likely to be in the region of $8.

Shareholders have earned a rate of return of 12% on their investments in recent years.
As a result of industrial development in the vicinity of Tiger plc, some highly profitable
investments are open to the firm in the short run. The Finance Director believes that it
should be possible to invest 60% of the company’s earnings in each of the next 3 years
in projects promising returns of 24%. It is most unlikely that projects yielding more
than 12% will be available after the end of the 3rd year. It is expected that the company
will then revert to paying out about 70% of earnings as dividends.

REQUIRED :
• Calculate the expected earnings & dividends per share in each of the next 4 years
• What is the market value of Tiger’s share likely to be at the end of the 3rd year?
• What is the current market price of Tiger’s share and how much of this is accounted
for by the firm’s abnormal growth opportunities?
• Calculate the prospective Price Earnings ratio (P/E) and state and comment on the
main assumptions on which the model(s) employed in your analysis are based.