• STOCK MARKETS
• The stock market is the segment of the capital market in which corporations raise
needed equity funds by issuing shares (Stock) to the investing public.
• The markets consist of Primary market and Secondary market.
Methods of Issuing Shares
Public offer
Private Placement (via OTC)
Rights Issue
Bonus Issue
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CHAPTER 6: THE STOCK MARKETS AND STOCK VALUATION
Public Issue (offer)
• Public issue refers to the issuing (selling or offering) of shares by a company to the
general public.
• If the issue is the first time it is known as Initial Public Offer (IPO).
• If the issue is not the first time it is called additional or secondary issue.
• The Company making the offer must meet the requirements of the Capital Market
Regulatory Agency (SEC), and Ghana Stock Exchange (GSE).
• Prospective investors must be provided with detailed information about the
company’s line of business, the purpose of issuing the security and current financial
conditions in a document called prospectus.
• The preparation of the prospectus is done with the help of an issuing house called
Investment Bank appointed by the company.
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STOCK MARKETS
Private Placement
• Private placement is the issue of securities to few identified institutional investors
such as Pension Funds, Insurance Firms, and Mutual Funds as well as other
companies and rich individuals.
• A private placement does not have to be registered with the SEC, but still needs to
present prospectus to prospective investors.
• Private placements are however more common in the sale of bonds than for shares.
Rights Issue
• This refers to the issue of additional shares to only existing shareholders of a
company. Each shareholder is issued rights to buy a specified number of additional
shares for each current holding (e.g. 3-to-1) at a specified price within a specified
time.
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STOCK MARKETS
• To execute a right offering the issuing company must first determine the price of
the additional issue and then find answers to the following questions;
How many shares should be sold?
How many rights should each shareholder have to buy one additional share?
What will be value of each right
What is the likely effect of the rights offer on the value of existing shares?
Illustration:
A Corporation has 300,000 existing shares with current market price of GH¢1.50 each.
The company plans to raise additional GH¢90,000 through rights issue at a set price of
GH¢1.20 each. Determine;
1. How many new shares should be issued to raise the amount?
2. How many rights will be required to purchase additional shares?
3. What will be the value of each right?
4. What is the effect of the issue on the current market price of existing shares?
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STOCK MARKETS
Solution
1.Number of new shares to issue = = = 75,000 shares
2. Number of rights to buy one new share = = 4:1 shares
3. Value of a right = = = GH¢0.06
4. Effect of rights issue on market price =
= = GH¢1.44 per shareThe price per share has fallen from GH¢1.50 to GH¢1.44.
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STOCK MARKETS
Bonus Issue:
• Bonus issue represents additional shares distributed to existing shareholders of a
company in place of cash dividend, in proportion to their current holdings.
• Bonus issues under Ghana’s Companies code, is called capitalization issue.
• Types of shares (stocks)
Ordinary Shares: Ordinary shares represent part-ownership of a corporation. The
holder is entitled to yearly dividend which varies and can only recover the
investment by selling the shares in the secondary market through the intermediation
of a stockbroker on the floor of the Stock Exchange.
• Preference Shares: Preference shares represent part-ownership yet have no voting
rights and holders receive a specified yearly fixed dividend. Preference shares have
priority on ordinary shares in the payment of dividends.
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STOCK MARKETS
• Types of preference shares
Cumulative or non-cumulative preference shares
Redeemable or irredeemable preference shares
Convertible non-convertible preference shares
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STOCK MARKETSPreference Shares
Stock Valuation Models
Unlike bonds, stocks are more difficult to value due to the following reasons:
The promised cash flows (dividends) are not known in advance with certainty.
The investment has no maturity.
Difficult to know the market required rate of return.
• Thus, stock valuation is done based on forecasts and some assumptions.
• The most illustrated stock valuation method is; the dividend discount method.
• The method requires the application of present value of future cash flows discussed
earlier.
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The dividend discount valuation methods
• Three theoretical assumptions exist under this model
Zero growth rate
Constant growth rate
Non-constant (Multiple) growth rate.
i) Zero Growth Model: This model assumes that dividend is not expected to grow
and the investment period is perpetual that is forever. Thus, Vo = , called
dividend growth model.
Illustration
• ABC company has just paid dividend of GH¢0.15 per share and has no intention of
reviewing it up for the coming years, what will be the value of the shares if the
required rate of return is 12%?
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Stock Valuation Models
• Value (price) of the share should be; Vo = = = GH¢1.25 per share
• Example of this is the irredeemable preference shares which has constant dividend
and zero-growth.
• Because the dividend is the same into the future it is viewed as ordinary perpetuity.
ii) Constant Growth Model: This model assumes that dividends each year will grow
at a constant rate indefinitely, so called a “growing perpetuity” .
Vo = = called dividend growth model
• Where Do is current year’s dividend, g is growth rate and r is required rate of
return.
• So if ABC company revised its dividend policy to increase its dividend payment at a
constant rate of 5% and required return rate is still 12%, what will the value of the
company?
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Stock Valuation ModelsThe dividend discount valuation methods
D1 = Do (1 + g)t
D1 = 0.15(1.05)1 = GH¢0.16
Vo = = GH¢2.29
Based on the above dividend policy,
(1) What will the dividend be in five years?
(2) What will the price be in five years?
(3) What will be the present value (price) based on the five-year forecasted price?
Solution(1) D5 = D0 x (1 + g)5 = 0.15 x (1.05)5 = GH¢0.19 per share
(2) P5 = = = = = GH¢2.86
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Stock Valuation ModelsThe dividend discount valuation methods
(2) continues
OR P5 = = = = GH¢2.86.
The 5th year price will now be discounted to get today’s price (Po).
(3) Po= = = = GH¢1.62
iii) Variable Growth Model
• Firms normally experience different growth phases along the path of their business
life- cycles.
• The variable growth model therefore incorporates periods of increasing and stable
growth rates.
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Stock Valuation ModelsThe dividend discount valuation methods
Illustration;
• UPS Ltd paid dividend of GH¢0.50 per share last year and expect it to grow at the
rate of 12% per annum for the next 3 years (supernormal growth) and to grow at a
steady rate of 7% per annum (normal growth) after the 3rd year into the future.
Investors’ required rate of return is however 15%. What should be the value (price)
of the company’s shares today?
Solution:Pattern of yearly dividend payments:Do = 0.50
D1 = 0.50(1.12) = 0.56
D2 = 0.56(1.12) = 0.63
D3 = 0.63(1.12) = 0.71
D4 = 0.71(1.07) = 0.76
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Stock Valuation ModelsThe dividend discount valuation methods
Vo =
But V3 = = = 9.50
Thus; Vo =
=
= 0.49 + 0.48 + 0.47 + 6.25
= GH¢7.69
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Stock Valuation ModelsThe dividend discount valuation methods
END OF CORPORATE FINANCE (PBBA 405)
END OF CORPORATE I (PBBF 305)
CORPRATE FINANCE II (PBBF 306) to continue next semester
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END OF SEMESTER
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