CORPORATE

FINANCIAL
Dr. Dung Thi Thuy
Nguyen

MANAGEMENT
 TOPIC 4
Equity Valuation
CRITICAL CONCEPTS
Choices of financing: Equity
Basic equity characteristics
Equity issuance and trading
Equity valuation: perpetuity
Equity valuation: growing perpetuity
Equity valuations: mixed growth + constant growth

Readings: Chapter 3. Textbook: Brealy et al. 2020

WHERE WE ARE IN THE BIG PICTURE?

Maximize value of the business (firm)

The Financing
The Investment Working Capital
Decision:
Decision Management
• Debt
(Capital Budgeting) Decision
• Equity
 FINANCING DECISION REVISITED.
CHOICES OF FINANCING. EQUITY
Debt Equity
Corporate firm
• Ownership interest in the
company’s profit in proportion
Debt • No ownership to the number of shares owned.
(Bonds) interest Profits may or may not be
distributed as dividends
• Fixed claim
• Residual claim
Assets
• High priority on • Lowest priority claim on
company’s cash company’s cash flows
• Infinite life
Equity
flows
• Management control
(Shares) • Fixed maturity (Shareholders have voting
• No management rights on appointment of board
members and on important
control
matters concerning the running
of the business)
 CHOICES OF FINANCING. COMMON
VERSUS PREFERENCE SHARES
Preference shares (hybrid):
Corporate firm 1. Like debt, preferred shares require a fixed dollar
payment - dividends (called preferred dividend).
Debt
Preferred dividend gets set at a stated rate that must be
(Bonds) paid before any dividends can be paid to common
shareholders
2. Like debt, no management control (do not carry voting
rights)
Assets 3. Like equity, preference shares have an infinite life
4. Intermediate priority to receive portion of firms’
Equity
assets: ranks behind bonds, ahead of stocks
(Shares)
Common shares:
1. Dividends are not an obligation nor pre-determined; but as
decided by the Board
2. Carry voting rights
PREFERENCE SHARE VS COMMON SHARE
 SHARE PRICE VERSUS SHARE
INTRINSIC VALUE
Market share price: Intrinsic share value:
• Market share prices are determined is the worth (fair value) of shares.
throughout the trading day as buyers • PV of the cash flows an
and sellers submit their orders investor who owns that security
• Investor receives information =>process can expect to receive in the
the information to form expectations future
=>trade on the share • PV reflects all available
• Demand > Supply =>price goes up information about future cash
• Demand < Supply =>price goes down flows from owning the security

Share intrinsic value = PV (all expected dividend

payments)
EXAMPLE 1. PREFERENCE SHARE’S INTRINSIC
VALUE
ABC Co. Ltd. wants to raise capital of $500,000 by issuing
perpetual preference shares. Suppose, that face value of the
issue is $100 and company promises to pay a dividend of
7% per share annually. Assume a discount rate of 5.04% p.a.
which reflects the riskiness of the company’s dividends.
What is the intrinsic value of the company preference share
today?
EXAMPLE 1. PREFERENCE SHARE’S INTRINSIC
VALUE
ABC Co. Ltd. wants to raise capital of $500,000 by issuing
perpetual preference shares. Suppose, that face value of the
issue is $100 and company promises to pay a dividend of
7% per share annually. Assume a discount rate of 5.04% p.a.
which reflects the riskiness of the company’s dividends.
What is the intrinsic value of the company preference share
today?
Intrinsic Value of preference shares = Preferred Div/ r
= 7/0.0504 = 138,8 $
COMMON SHARES VALUATION- A GENERAL CASE
You buy a stock from a company. your cash payoff comes in two
forms: (1) cash dividends and (2) capital gains or losses.
Suppose that the current price of a share is P0, that the expected
price at the end of a year is P1, and that the expected dividend
per share is D1. The rate of return that investors expect from this
share over the next year is defined as the expected dividend per
share DIV1 plus the expected price appreciation per share P1 –
P0, all divided by the price at the start of the year P0:
COMMON SHARES VALUATION- A GENERAL CASE
You buy a stock from a company. your cash payoff comes in two
forms: (1) cash dividends and (2) capital gains or losses.
Suppose that the current price of a share is P0, that the expected
price at the end of a year is P1, and that the expected dividend
per share is D1. The rate of return that investors expect from this
share over the next year is defined as the expected dividend per
share DIV1 plus the expected price appreciation per share P1 –
P0, all divided by the price at the start of the year P0:
P0 = D1 + D2 +…….+ Dt + Pt
(1+r) (1+r)2 (1+r)t
 COMMON SHARES VALUATION- A SPECIAL CASE
…. GROWING PERPETUITY CASH FLOWS
A growing perpetuity is a cash flow that is expected to grow at a constant
rate forever

CFs grows forever and ever

𝐶1 𝐶2 = 𝐶1 × (1 + 𝑔) 𝐶3 = 𝐶2 × (1 + 𝑔) … 𝐶𝑡 = 𝐶0 × (1 + 𝑔)𝑡

t=0 t=1 t=2 t=3 T, time

∞
𝑫𝟏
𝑃0 = , where
𝑟−𝑔
𝑫𝟏 is the cash flow occurring at the end of the first period
r is interest rate
g is the cash flows’ constant growth rate
𝑫𝟏 = 𝑫0 × 1 + 𝑔
EXAMPLE 2. FIND INTRINSIC SHARE
VALUE. GROWING PERPETUITY
A company is expected to pay a dividend of $5 one year from
now. A growth rate in dividends is expected at 4% p.a. Investors
who own shares in similar types of companies expect to earn a
rate of return of 18% p.a.
What is the intrinsic value of the company’s share?
EXAMPLE 2. FIND INTRINSIC SHARE
VALUE. GROWING PERPETUITY
A company is expected to pay a dividend of $5 one year from
now. A growth rate in dividends is expected at 4% p.a. Investors
who own shares in similar types of companies expect to earn a
rate of return of 18% p.a.
What is the intrinsic value of the company’s share?
G=4%; r = 18%
𝑫𝟏
𝑃0 = = 5 = 35.7$
𝑟−𝑔

(0.18-0.04)
EXAMPLE 3. FIND INTRINSIC SHARE
VALUE. GROWING PERPETUITY
A Company has just paid a dividend of $5. A growth rate in
dividends is expected at 4% p.a. Investors who own shares in
similar types of companies expect to earn a rate of return of
18% p.a
What is the intrinsic value of the company’s share?
EXAMPLE 3. FIND INTRINSIC SHARE
VALUE. GROWING PERPETUITY
A Company has just paid a dividend of $5. A growth rate in
dividends is expected at 4% p.a. Investors who own shares in
similar types of companies expect to earn a rate of return of
18% p.a. => Div1 = 5 *(1+0.04) = 5,2
What is the intrinsic value of the company’s share?
𝑫𝟏
𝑃0 = = 5 (1+0.04) = 37,14 $
𝑟−𝑔

(o.18-0.04)
 GROWING PERPETUITY FOR SHARE
VALUATION. DIVIDEND DISCOUNT MODEL
𝑫𝟏
𝑃𝑉 𝑔𝑟𝑜𝑤𝑖𝑛𝑔 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦: 𝑃0 =
𝑟−𝑔

𝑫𝟏 = 𝑫𝟎 × 1 + 𝑔

𝑫𝟎 × 1+𝑔
𝑃𝑉 𝑔𝑟𝑜𝑤𝑖𝑛𝑔 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦: 𝑃0 = , r>g
𝑟−𝑔

𝐷1 is the dividend occurring at the end of the first period

r is the discount rate per period
g is the constant rate of growth of the dividend (D) per period
Growing perpetuity gives a relation between current stock intrinsic
value, dividend, dividend growth rate and the expected return. Knowing
three of the variables determines the fourth
EXAMPLE 4. SHARE INTRINSIC VALUE AND
REQUIRED RATE OF RETURN
A company expects to pay a dividend of $1.00 one year
from today. The dividends after one year are then expected
to grow at a constant rate of 2% per year into the indefinite
future.
What is the value of this company’s share today if required
rate of return is 15% p.a. ?
What is the value of this company’s share if required rate
of return is 10% p.a?
EXAMPLE 4. SHARE INTRINSIC VALUE AND
REQUIRED RATE OF RETURN
A company expects to pay a dividend of $1.00 one year
from today. The dividends after one year are then expected
to grow at a constant rate of 2% per year into the indefinite
future. => D1 = 1$; g= 0.02
I. What is the value of this company’s share today if
required rate of return is 15% p.a. ? r = 0.15
II. What is the value of this company’s share if required
rate of return is 10% p.a? => r=0.1
Pa = 1/ (0.15-0.02) = 7.69
Pb = 1/ (0.1-0.02)= 12.5
SHARE INTRINSIC VALUE. GROWING
PERPETUITY. SOLVE FOR R
Rearrange the formula, we can find the required rate of
return

D1 𝐷1
PV0 = 𝑟=𝑔+
𝑃𝑉0
r -g
(From shareholders/ investor side) Dividend Yields
Required/ Expected return rate
Growth Rate
(from a company) Cost of equity capital
Market capitalization rate
EXAMPLE 5. SHARE INTRINSIC VALUE.
GROWING PERPETUITY. SOLVE FOR R
Lucas Company’s share is expected to pay a dividend of
$0.17 at the end of the current year. Company’s future
dividends are expected to grow at a constant rate of 2%
annual rate. Current share price is $8.66.
What is the implied required rate of return for investors in
Lucas Company’s shares?
EXAMPLE 5. SHARE INTRINSIC VALUE.
GROWING PERPETUITY. SOLVE FOR R
Lucas Company’s share is expected to pay a dividend of
$0.17 at the end of the current year. Company’s future
dividends are expected to grow at a constant rate of 2%
annual rate. Current share price is $8.66.
What is the implied required rate of return for investors in
Lucas Company’s shares?
𝐷1
𝑟=𝑔+ = 0.02 + 0.17 = 0.04 (4%)
𝑃𝑉0

8.66
 KEY INSIGHTS
1. Shares are equity capital that firms issue as another way (bonds being one
way) of sourcing cash from investors. In return for buying a share,
investors become owners of the business
2. Profit distributions to shareholders (dividend) differ and depend on the
types of shares an investor owns: preference or common shares
3. The value of preference and ordinary shares is the present value of all
future cash flows (dividends) an investor who owns that preference share
can expect to receive in the future
4. Since preferred dividends are a fixed payment of dividends into the
indefinite future, the value of a preference share is therefore calculated
using the present value of a perpetuity
KEY INSIGHTS. CONTINUED
1. Intrinsic value is the worth (fair value) of shares.
Share intrinsic value = PV (all expected dividends)
2. The ordinary and growing perpetuity formulae gives a value at time t for
dividends starting at time t+1
3. Dividend streams can take on different forms:
i. Dividends may be fixed (preference share, zero growth)
ii. Dividends may have a constant growth pattern (they grow forever at a
constant rate g)
iii. Dividends may grow at a non-constant rate and then at a constant rate
4. Required rate of return is sum of dividend yield and growth rate. It reflects a
particular risk class
5. Share intrinsic value may defer from share price
 QUESTION1
Suppose a share is expected to pay a $7.50 dividend every
half-year indefinitely and the required return is 12% p.a.
with half-yearly compounding. What is the value of this
share?
A. $62.5
B. $63
C. $125
D. $75
E. None of these
QUESTION 2
Suarez Goal Inc. just paid dividend of 31.4c. The average
growth rate of Suarez Goal Inc. dividends has been 4.9%
p.a. during the last six years. If Suarez Goal Inc
shareholders have a required return of 9.25% what is the
current estimated value of Suarez Goal Inc. shares?

A. $3.56
B. $7.22
C. $3.39
D. $7.57
E. None of the above
QUESTION 3
A firm is expected to pay a $2.35 dividend one year from
now. The dividend is expected to grow at 3% p.a.
Shareholders expect a return of 11% p.a. What is the
estimated value of this share?
A. $22.00
B. $30.26
C. $21.36
D. $29.38
E. None of the above
QUESTION 4
FastBiz Inc. is currently not paying a dividend. You
predict that, in six years, FastBiz will pay a dividend
for the first time. The dividend will be $0.40 per
share. You expect that this dividend will grow at a
rate of 8% per year indefinitely. The required return
on companies such as FastBiz inc. is 17% p.a. What
is the fair value of the ordinary share today?
A. $4.44
B. $1.73
C. $2.03
D. $4.80
E. $2.19
QUESTION 5
You forecast that ASN Corporation will pay the following
dividends at the end of each of the next three years: $2.00,
$3.00 and $3.75. After year 3 the dividends will grow at a
constant rate of 6% per year. The required return is 13%
p.a. What is the value of an ordinary ASN share today?
A. $46.07
B. $56.79
C. $43.47
D. $41.25
E. $43.85