Hello sir
I have just startrd watching this video and I feel my heads going round in circles.
sir ealier you have stated that the MV of shares is determined using the future expected divdends & Re. But in this video, u hv said that the Re is determined using the future expected dividends and the MV quoted in the S/E.
but how can we do that if we need the Re in the first place to determine the market value?
or is the application of growth model just suitable for unquoted co.’s?
And if so, how is the share price of quoted co.’s determined?
Also,since one of the many limitations of the growth model is that the Re used in the computation of MV is that it is just an estimate,i figured that there must be a certain way of estimating it rather than just working the formula backwards.
I fear I am getting everything jumbled up

if think you have to take it like this, in the first lecture on valuation of securities, you were shown how to calculate mkt price, which in its simplest way is the dividend divided by the expected rate of return (Re).The unknown was the market price.

As stated in page 83 of lecture notes,mkt price is determined by shareholders, the price at which they wud be prepared to pay on stock exchange.

Lets say you have a share of $1 nominal value, which gives you a dividend of 20c the year. The rate of interest is 10%. At what rate would a person normally agree to buy your share at most? Answer is nearly to the same rate at which you would be earning interest at the bank. I dnt think you would sell it for 1$, because you are getting 20% off it (20c / $1). $1 would earn an interest of 10c at the bank. People would not buy your share for $3, earning just 20c as dividend coz the bank would earn the an interest of 30p.

At most, people would be willing to pay X$ which would earn them a dividend of 20c at a rate of return similar to the bank (10%), hence, would pay 20c/10% = $2 at most for the share because it would get them equivalent return to bank.

Now you yourself, would you be ready to pay $3 for a share which earns you 20c whilst the bank offers an interest of 10% per annum? Answer is obviously no. However, if the share is 1.95$, you would probably go for the share instead of the bank. The maximum amount you would be likely to pay would be the equivalent of rate of interest earned throuh the bank which is $2.

The rate of return is not to be confused with the rate of interest. People may expect a higher return by investing in shares as compared to bank interest, given the risk associated.

Now, if you know the market price and the dividend, just find the unknown, that is the expected rate of return

It does actually:)
it was the bank interest rate portion I was missing out.
let me still clarify- so what your saying is-the share price is decided keeping in mind the int. rate and what rate of return the shateholders are likely to require because of the present interest rate. And then setting a price thats not going to make the co. lose out but is attractive to shareholders at the same time right?
thanks a bunch!!!!

This sort of question really belongs in the Ask the Tutor Forum rather than as a comment on a lecture!

Shareholders determine the price of the shares based on the dividends they expect and the return they require.

For a quoted company we know what the share price is, and so we can ‘work backwards’ to determine what return shareholders are requiring and therefore what the company needs to give them (and therefore what return the company needs to earn from projects in order to satisfy the shareholders).

Dear Sir,
Can you help me with this question?…….
A Co has just paid a dividend of 23 cents and it is expected to remain the same next year and increase by 3 percent thereafter. What is the current market value of the share if the required return is 12 percent? The answer given is 2.56….I don’t get it.

In future please ask questions like this in the Ask the Tutor Forum – not as a comment on a lecture!

We use the formula from the formula sheet: (Do(1+g))/(Re – g)
The top bit on the formula (Do(1+g)) is next years dividend which is usually the current dividend times (1+g). However in this question, next years dividend is 23c and not 23c plus growth.

Although from year to year the growth may be positive or negative, we are after the average growth per year over the whole period. This will always be positive in the exam.

The only relevant figures here are 28,000 and 33,000 – the earliest and latest dividends.

I assume you are referring to the market value of the debentures.
The price given in the question is 90, but since interest is about to be paid this is a cum interest value. We need the ex interest value which is 90 – 12 = 78.

(In future please ask this sort of question in the F9 Ask the Tutor Forum, and not as a comment on a lecture )

Did you read my previous reply? Because I asked you not to post this sort of question as a comment on a lecture, and also because it is exactly the same reason.
The price in the question is 95. The question says that interest is about to be paid and therefore it is a cum interest price. The interest is 5, and therefore the ex interest price is 90.

Again, I do suggest that you watch our free lectures on this.

The videos are working fine, and so the problem must be at your end.
Please go to the support page – the link is above – and you should find a solution there.

They are enough to be able to pass the exam well, provided that you have a current edition of a Revision Kit from one of the ACCA approved publishers. They contain lots of exam standard questions to practice on, and it is vital that you have lots of question practice.

Thank you for another great lecture, I have only 1 query. Regarding the rearranging of the growth model formula to find the shareholders required return, I have been happily rearranging as you instructed when I came across a question in my BPP revision guide that used a different formula. As I don’t expect you to have a copy of the textbook I will rewrite the information that I was given:

“Ordinary shares are quoted at 80c, assume the market estimate of the next dividend is 4c, growing at 12% p/a indefinitely. There are 10400 shares in issue. What is the cost of capital of these shares (for the purpose of WACC)?”

I calculated this as I believed correctly using your method as follows:

Re = 0.04 (1 + 12%) + 12% = 17.6%
—————–
0.80

The answer in the textbook however showed the following:

Ke = 0.04 + 12% = 17%
—–
0.80

My question to you would be, is there a difference between Re and Ke (as symbols) and am I therefore taking your formula in vain, or is this just another textbook example of the publisher getting the answer wrong?

If you get chance to reply before my exam on Friday that would be fantastic!

It is not because of the symbols!
Do(1+g) in the formula is the dividend in one years time.
Since this question says that the next dividend (i.e. the dividend in one years time) will be 4c, then this is equal to Do(1+g)

hi sir I was revising this for p4 in june attempt and in example 1 we got a return of 12.5%. I just want to ask that will we be giving this return on the nominal value or on the market value because if we give this on nominal value the dividend would decrease from 30c to 12.5c?

Let me start by saying your lectures are great and easy to go through. I don’t get bored. I think I have gone through 30 in 4 days or something! Also, you explain everything very well. You seem to cover every detail yet don’t take long to do so.

Anyway, I have a similar question to what Uzair asked above. We calculated 12.5% as the cost of equity (thus the estimated shareholders’ required rate of return).

However, raising money from shareholders in this case is through new issue of shares, isn’t it? So if we do decide to issue new shares, where does the 12.5% come into play?

Are we promising dividends at 12.5% of our profit after tax (and thus they would be similar to preference shares)?
I might be overlooking something very obvious but if we estimate that our cost of equity is 12.5%, how are we promising that 12.5% interest to investors each year if we do issue new shares? Will we tell them our estimated future dividends? Will we give them the estimated growth rate of dividends/profits?
It is easy to understand it in debentures, where we are giving a fixed interest. But how do we pay out a fixed interest on ordinary share capital?

Or is it just that since we already know the market value, we are working backwards and seeing how much return our existing shareholders are getting on average? (Because the rate of return is already taken into account in determining the market value). I don’t know if I am making any sense!

Also, if we do indeed issue new shares, do we issue them at the nominal value of $1? Or will we open a share premium of $1.4 per share in addition to the nominal value to match the market price?

I don’t know how relevant these questions are for the F9 exam, but better to clear them up.

Shareholders could put their money in the bank and be earning interest, and so will only be prepared to invest money in the company if they expect to get a better return. Investing money could be by buying shares, or allowing the company to retain earnings (which is money to which the shareholders are entitled to).
They will want a return either by way of dividend or by way of capital growth – either way it means that the company must use their money to get a return at least as high as that required by shareholders.

The problem is in deciding what return it is that shareholders require.

The way we attempt to find out is by looking at the market value of the share currently. Since the market value is the present value of expected dividends, we work ‘backwards’ using the dividend growth formula. In theory this is fine, but the problem is that we do not know what dividend growth shareholders are expecting – we are forced to make an estimate which could be wrong.

The other way (which you will cover in the capital asset pricing model lectures) is to calculate the riskiness of the shares (measured by the beta). Since the return required by shareholders (and therefore the return that the company has to achieve) is determined by the riskiness of the shares, then if we can calculate the beta and therefore the return required.
Again, there are limitations as to the accuracy, but it is regarded as a better indicator.

Remember that the company raises money from shareholders not only by issuing shares – retaining earnings is using shareholders money as well.
If the company does issue shares then they would be extremely unlikely to issue them at nominal value. They would normally issue them at a price that was at least equal to the current market value of existing shares (unless, or course, it was a rights issue). The fact that this would increase the share premium account balance is not relevant – we are not interested in the financial accounts aspect.

Hi Sir,
Thank you for showing us how to calculate to the fourth root, however you didn’t mention how to calculate to the fifth root if five years is given in the exam. Would it then be a matter of calculating to the third root and then to the second root? Or calculating to the second root first and then the third root second? Or is there another way?
Thanks for your help and quick response as exam is only 3 weeks away
Sonria.

No. The only way to calculate a fifth root is to use a calculator that has this function on it (the ability to take any root, be it the fifth root or sixth root or whatever).

You do need to invest in a scientific calculator to be safe.

It cannot be a scientific calculator if it does not have the ability to take the nth root (it might be the second function about x^y).
If you want to be safe for the exam, then you do need a scientific calculator.

I enjoyed the session. I am a person who cannot cram things I don’t understand, however if I do understand something I will very rarely every forget it. So to Mr. Moffat, thanks for helping me to understand the formula so that I won’t have to cram it off…

Hi guys,
I really cannot get to calculate the fourth roots using my calculator. the calculator is CASIO fx-82MS. Your help will be much appreciated. Thanks

Thanks for your reply Mr. Moffat, however I am not getting the same result. I am calculating it as follows: 33000/28000= x2 (the first result I take the square root- 1.3890) = x2 (the second result I take the second square root-1.9294), eventually I am getting 1.9294 as a final result. Thank you very much

I do not have your calculator, but there must be a square root button on it.
33000/28000 = 1.1786. Square root once gives 1.0856, and square root again gives 1.0419

Hey you guys! Is it just me, or do you also answer Mr John when he asks: anybody? alright? etc.. even though you are just facing the laptop screen! O.o

sayma says

Hello sir

I have just startrd watching this video and I feel my heads going round in circles.

sir ealier you have stated that the MV of shares is determined using the future expected divdends & Re. But in this video, u hv said that the Re is determined using the future expected dividends and the MV quoted in the S/E.

but how can we do that if we need the Re in the first place to determine the market value?

or is the application of growth model just suitable for unquoted co.’s?

And if so, how is the share price of quoted co.’s determined?

Also,since one of the many limitations of the growth model is that the Re used in the computation of MV is that it is just an estimate,i figured that there must be a certain way of estimating it rather than just working the formula backwards.

I fear I am getting everything jumbled up

Abhishek says

My opinion:

if think you have to take it like this, in the first lecture on valuation of securities, you were shown how to calculate mkt price, which in its simplest way is the dividend divided by the expected rate of return (Re).The unknown was the market price.

As stated in page 83 of lecture notes,mkt price is determined by shareholders, the price at which they wud be prepared to pay on stock exchange.

Lets say you have a share of $1 nominal value, which gives you a dividend of 20c the year. The rate of interest is 10%. At what rate would a person normally agree to buy your share at most? Answer is nearly to the same rate at which you would be earning interest at the bank. I dnt think you would sell it for 1$, because you are getting 20% off it (20c / $1). $1 would earn an interest of 10c at the bank. People would not buy your share for $3, earning just 20c as dividend coz the bank would earn the an interest of 30p.

At most, people would be willing to pay X$ which would earn them a dividend of 20c at a rate of return similar to the bank (10%), hence, would pay 20c/10% = $2 at most for the share because it would get them equivalent return to bank.

Now you yourself, would you be ready to pay $3 for a share which earns you 20c whilst the bank offers an interest of 10% per annum? Answer is obviously no. However, if the share is 1.95$, you would probably go for the share instead of the bank. The maximum amount you would be likely to pay would be the equivalent of rate of interest earned throuh the bank which is $2.

The rate of return is not to be confused with the rate of interest. People may expect a higher return by investing in shares as compared to bank interest, given the risk associated.

Now, if you know the market price and the dividend, just find the unknown, that is the expected rate of return

Hope this answers your concerns

sayma says

It does actually:)

it was the bank interest rate portion I was missing out.

let me still clarify- so what your saying is-the share price is decided keeping in mind the int. rate and what rate of return the shateholders are likely to require because of the present interest rate. And then setting a price thats not going to make the co. lose out but is attractive to shareholders at the same time right?

thanks a bunch!!!!

John Moffat says

This sort of question really belongs in the Ask the Tutor Forum rather than as a comment on a lecture!

Shareholders determine the price of the shares based on the dividends they expect and the return they require.

For a quoted company we know what the share price is, and so we can ‘work backwards’ to determine what return shareholders are requiring and therefore what the company needs to give them (and therefore what return the company needs to earn from projects in order to satisfy the shareholders).

halisyinanc says

Thank you John , this is great help!

claudia1 says

Dear Sir,

Can you help me with this question?…….

A Co has just paid a dividend of 23 cents and it is expected to remain the same next year and increase by 3 percent thereafter. What is the current market value of the share if the required return is 12 percent? The answer given is 2.56….I don’t get it.

John Moffat says

In future please ask questions like this in the Ask the Tutor Forum – not as a comment on a lecture!

We use the formula from the formula sheet: (Do(1+g))/(Re – g)

The top bit on the formula (Do(1+g)) is next years dividend which is usually the current dividend times (1+g). However in this question, next years dividend is 23c and not 23c plus growth.

So it becomes 23/(0.12-0.03) = 256 ($2.56)

aliimranacca007 says

In 1998 32000

in 1999 31000

there is no growth here goes down…

Is there no any effect on solution .i.e always use same formola wheather grow or goes down?

John Moffat says

I assume you are referring to example 4.

Although from year to year the growth may be positive or negative, we are after the average growth per year over the whole period. This will always be positive in the exam.

The only relevant figures here are 28,000 and 33,000 – the earliest and latest dividends.

Iryna says

H John I am puzzled practice question 12 C in the answer market value is 78 how did we came to that . Please advice

John Moffat says

I assume you are referring to the market value of the debentures.

The price given in the question is 90, but since interest is about to be paid this is a cum interest value. We need the ex interest value which is 90 – 12 = 78.

(In future please ask this sort of question in the F9 Ask the Tutor Forum, and not as a comment on a lecture )

Iryna says

Hi the same question on F9 practice question 12 d in answer calculations Kd how did we worked out market value $90

John Moffat says

Did you read my previous reply? Because I asked you not to post this sort of question as a comment on a lecture, and also because it is exactly the same reason.

The price in the question is 95. The question says that interest is about to be paid and therefore it is a cum interest price. The interest is 5, and therefore the ex interest price is 90.

Again, I do suggest that you watch our free lectures on this.

Promise says

Sorry Sir my calculator is giving me different answer for growth rate.I get 4.34248 before deducting 1

John Moffat says

I assume that you are referring to example 4?

If you are, then I don’t think it is the fault of your calculator but probably you pressing the wrong buttons

(1 + g) = fourth root of (33000/28,000) = fourth root of 1.178571

To take the fourth root, either use the relevant button or take the square root twice. In either case it comes to 1.04193.

(It could not possibly come to 4.34248!!)

fahim231 says

hi sir i am confused regarding the growth forumla…….you say after 1 year it will be (1+g)? so after 2 years would it not be (2+g)?

Thanks in advance

John Moffat says

No – it would not!

Imagine it is 100 now, growing at 10%

In 1 year it becomes 100 + (0.10 x 100) = 110 (or 100 x 1.1)

In 2 years it becomes 110 + (0.10 x 110) = 121

This is the same as 110 x 1.10, which is the same as 100 x (1.10)^2

Try it on your calculator and see.

Every time we add on 10%, we multiply by 1.10

If we do it twice, then we multiply by 1.10 twice.

Milan says

So Sad! I can’t download ACCA video lecture. No option to download. Why? Plz help someone.

opentuition_team says

You can watch lectures on line, as many times as you want, FREE!

John Moffat says

It is the only way that we can keep this website free of charge.

ngao says

I have been trying to listen to some videos but am failing what could be the problem?

John Moffat says

The videos are working fine, and so the problem must be at your end.

Please go to the support page – the link is above – and you should find a solution there.

ngao says

Will try and do that. Thanks

ngao says

Are video lectures and class notes enough to make one pass?

John Moffat says

They are enough to be able to pass the exam well, provided that you have a current edition of a Revision Kit from one of the ACCA approved publishers. They contain lots of exam standard questions to practice on, and it is vital that you have lots of question practice.

Donna says

Dear John,

Thank you for another great lecture, I have only 1 query. Regarding the rearranging of the growth model formula to find the shareholders required return, I have been happily rearranging as you instructed when I came across a question in my BPP revision guide that used a different formula. As I don’t expect you to have a copy of the textbook I will rewrite the information that I was given:

“Ordinary shares are quoted at 80c, assume the market estimate of the next dividend is 4c, growing at 12% p/a indefinitely. There are 10400 shares in issue. What is the cost of capital of these shares (for the purpose of WACC)?”

I calculated this as I believed correctly using your method as follows:

Re = 0.04 (1 + 12%) + 12% = 17.6%

—————–

0.80

The answer in the textbook however showed the following:

Ke = 0.04 + 12% = 17%

—–

0.80

My question to you would be, is there a difference between Re and Ke (as symbols) and am I therefore taking your formula in vain, or is this just another textbook example of the publisher getting the answer wrong?

If you get chance to reply before my exam on Friday that would be fantastic!

Many thanks Donna

John Moffat says

It is not because of the symbols!

Do(1+g) in the formula is the dividend in one years time.

Since this question says that the next dividend (i.e. the dividend in one years time) will be 4c, then this is equal to Do(1+g)

Erica says

Sir John, between chapter 17 – 25 of this F9 subject, which are the ones that are related to FFM?

John Moffat says

None of these chapters are needed for FFM

Erica says

O really? I thought interest rate and chapter 25 are mentioned in FFM..

acca2050 says

Whats the way to calulate simple method of growth. Adding all figures and divide by 2?

John Moffat says

You would add all the growth rates and divide by the number of them.

However, in the exam we always calculate the growth properly, as I do in this example.

Muhammad Uzair says

hi sir I was revising this for p4 in june attempt and in example 1 we got a return of 12.5%. I just want to ask that will we be giving this return on the nominal value or on the market value because if we give this on nominal value the dividend would decrease from 30c to 12.5c?

John Moffat says

The market value of a share is determined by the dividend they expect and the rate of return that they require.

So the required return (and therefore the cost of equity) is calculated using the expected dividends and the market value (not the nominal value).

opktun says

Hello Mr. Moffat

Let me start by saying your lectures are great and easy to go through. I don’t get bored. I think I have gone through 30 in 4 days or something! Also, you explain everything very well. You seem to cover every detail yet don’t take long to do so.

Anyway, I have a similar question to what Uzair asked above. We calculated 12.5% as the cost of equity (thus the estimated shareholders’ required rate of return).

However, raising money from shareholders in this case is through new issue of shares, isn’t it? So if we do decide to issue new shares, where does the 12.5% come into play?

Are we promising dividends at 12.5% of our profit after tax (and thus they would be similar to preference shares)?

I might be overlooking something very obvious but if we estimate that our cost of equity is 12.5%, how are we promising that 12.5% interest to investors each year if we do issue new shares? Will we tell them our estimated future dividends? Will we give them the estimated growth rate of dividends/profits?

It is easy to understand it in debentures, where we are giving a fixed interest. But how do we pay out a fixed interest on ordinary share capital?

Or is it just that since we already know the market value, we are working backwards and seeing how much return our existing shareholders are getting on average? (Because the rate of return is already taken into account in determining the market value). I don’t know if I am making any sense!

Also, if we do indeed issue new shares, do we issue them at the nominal value of $1? Or will we open a share premium of $1.4 per share in addition to the nominal value to match the market price?

I don’t know how relevant these questions are for the F9 exam, but better to clear them up.

Thanks for your time.

Regards

Omar Parvez

John Moffat says

Shareholders could put their money in the bank and be earning interest, and so will only be prepared to invest money in the company if they expect to get a better return. Investing money could be by buying shares, or allowing the company to retain earnings (which is money to which the shareholders are entitled to).

They will want a return either by way of dividend or by way of capital growth – either way it means that the company must use their money to get a return at least as high as that required by shareholders.

The problem is in deciding what return it is that shareholders require.

The way we attempt to find out is by looking at the market value of the share currently. Since the market value is the present value of expected dividends, we work ‘backwards’ using the dividend growth formula. In theory this is fine, but the problem is that we do not know what dividend growth shareholders are expecting – we are forced to make an estimate which could be wrong.

The other way (which you will cover in the capital asset pricing model lectures) is to calculate the riskiness of the shares (measured by the beta). Since the return required by shareholders (and therefore the return that the company has to achieve) is determined by the riskiness of the shares, then if we can calculate the beta and therefore the return required.

Again, there are limitations as to the accuracy, but it is regarded as a better indicator.

Remember that the company raises money from shareholders not only by issuing shares – retaining earnings is using shareholders money as well.

If the company does issue shares then they would be extremely unlikely to issue them at nominal value. They would normally issue them at a price that was at least equal to the current market value of existing shares (unless, or course, it was a rights issue). The fact that this would increase the share premium account balance is not relevant – we are not interested in the financial accounts aspect.

sonria says

Hi Sir,

Thank you for showing us how to calculate to the fourth root, however you didn’t mention how to calculate to the fifth root if five years is given in the exam. Would it then be a matter of calculating to the third root and then to the second root? Or calculating to the second root first and then the third root second? Or is there another way?

Thanks for your help and quick response as exam is only 3 weeks away

Sonria.

John Moffat says

No. The only way to calculate a fifth root is to use a calculator that has this function on it (the ability to take any root, be it the fifth root or sixth root or whatever).

You do need to invest in a scientific calculator to be safe.

sonria says

Thank you for replying. I do have a scientific calculator however it only has square and cube roots… Should I be worried?

John Moffat says

It cannot be a scientific calculator if it does not have the ability to take the nth root (it might be the second function about x^y).

If you want to be safe for the exam, then you do need a scientific calculator.

sonria says

Ok, thank you

kryssy says

I enjoyed the session. I am a person who cannot cram things I don’t understand, however if I do understand something I will very rarely every forget it. So to Mr. Moffat, thanks for helping me to understand the formula so that I won’t have to cram it off…

l_ACCA says

Good video. So easy to understand the theory and calculations.

MIB says

Hi guys,

I really cannot get to calculate the fourth roots using my calculator. the calculator is CASIO fx-82MS. Your help will be much appreciated. Thanks

John Moffat says

Try taking the square root twice

MIB says

Thanks for your reply Mr. Moffat, however I am not getting the same result. I am calculating it as follows: 33000/28000= x2 (the first result I take the square root- 1.3890) = x2 (the second result I take the second square root-1.9294), eventually I am getting 1.9294 as a final result. Thank you very much

John Moffat says

What you are doing is squaring it!

(1.3890 x 1.3890 = 1.9294)

I do not have your calculator, but there must be a square root button on it.

33000/28000 = 1.1786. Square root once gives 1.0856, and square root again gives 1.0419

MIB says

Correct. I was just squaring it. Thanks for your continued support.

mahoysam says

Hey you guys! Is it just me, or do you also answer Mr John when he asks: anybody? alright? etc.. even though you are just facing the laptop screen! O.o

Mike says

Hi!

The calculated growth rate is also known as Compound annual growth rate (CAGR) correct?

BR,

Mike