TRINITY INSTITUTE OF PROFESSIONAL STUDIES

Sector – 9, Dwarka Institutional Area, New Delhi-75Affiliated Institution of G.G.S.IP.U,

Delhi

BBA(G) Vth SEM PAPER CODE:BBA309PAPER ID: 17309

VALUATION OF SHARES

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

Valuation of Shares

A company may issue two types of shares: preference shares ordinary shares

Features of Preference and Ordinary Shares Claims Dividend Redemption Conversion 

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

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:

10

1

PDIV(1 ) (1 )

nn

t nt p p

PP

k k

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

Value of a Preference Share-Example

Suppose an investor is considering the purchase of a 12-year, 10% Rs 100 par value preference share. The redemption value of the preference share on maturity is Rs 120. The investor’s required rate of return is 10.5 percent. What should she be willing to pay for the share now? The investor would expect to receive Rs 10 as preference dividend each year for 12 years and Rs 120 on maturity (i.e., at the end of 12 years).

We can use the present value annuity factor to value the constant stream of preference dividends and the present value factor to value the redemption payment.

71.10221.3650.66302.01206499.610)105.1(

120)105.1(105.0

1105.0110 12120

Rs

P

Note that the present value of Rs 102.71 is a composite of the present value of dividends, Rs 66.50 and the present value of the redemption value, Rs 36.21.The Rs 100 preference share is worth Rs 102.71 today at 10.5 percent required rate of return. The investor would be better off by purchasing the share for Rs 100 today.

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

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.

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

Different approaches for valuing common stockDividend growth modelUsing the multiples of comparable

firms

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

Dividend growth modelValue of a stock is the present value of the future dividends expected to be generated by the stock. It is also called capitalising the future dividend stream at the opportunity cost of capital

ekD1

e3

e

32

e

21

e

10

)k(1D ...

)k(1D

)k(1D

)k(1D P

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

Constant growth stock

A stock whose dividends are expected to grow forever at a constant rate, g.

D1 = D0 (1+g)1

D2 = D0 (1+g)2

Dt = D0 (1+g)t

If g is constant, the dividend growth formula converges to:

g -kD

g -kg)(1D P

e

1

e

00

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

If D0 = Rs.2 and g is a constant 6%, find the expected dividend stream for the next 3 years, and their PVs if cost of equity is 13%.

1.87611.7599

D0 = 2.00

1.6509

ke = 13%

g = 6%0 1

2.247

2

2.382

3

2.12

TRINITY INSTITUTE OF PROFESSIONAL STUDIESSector – 9, Dwarka Institutional Area, New Delhi-75

WHAT IS STOCK’S MARKET VALUE?

Using the constant growth model:

Rs.30.29

0.07

2.12 Rs.

0.06 - 0.132.12 Rs.

g - kD Pe

10