Hi Sir, when we use the dividend valuation model, are we getting the market value of the company as whole( Equity+Debt) or the market cap(equity only)?

So if we took the share price X no. of shares, would that mean we get the total market value of equity + debt or just equity?

JojoBeatsays

Correction : The technical article says market value of co = future cash flows/WACC, so does that mean equity + debt since WACC includes both? Sorry for asking so many questions and thank you for being patient!

The market value of shares is the PV of the dividends discounted at the cost of equity.

The PV of the operating cash flows (before interest) discounted at the WACC is the total market value of the company (equity + debt).
(Although this second statement is more relevant for Paper AFM)

No problem asking questions, although questions (as opposed to comments) are better asked in the Ask the Tutor Forum – I do not always see questions here, but I always see them and answer them in the Ask the Tutor Forum.

The required rate of return to shareholders is not after tax. Tax has no effect on the cost of equity.

When calculating the market value of debt we use the investors required rate of return (which is before tax) because it is the investors who determine the market value and they are not affected by company tax.

Have you watched the lectures on the valuation of debt?

JojoBeatsays

Sir, is it right to say we’ve discounted the dividend growth in perpetuity to get present value at time 2 however we must discount it again to get present value in time 0?

So its also right to say that if we discounted 20(1.04) with 15% at time 3, it would’ve not have taken into account the future expected dividend beyond time 3?

No it is not correct. If the dividend is growing in perpetuity then we use the dividend growth formula to get the present value at time 2. I actually explain and illustrate this in my lectures.

Yes, and I explain this in my lectures. If dividends are expected to grow by (say) 5% a year, then the market value will also be expected to grow by 5% as year as well. Again, I explain why in the lectures.

Sir why is it called the current market value? Does this represent the current market price or the price in which share should be bought if the given rate of return and the dividend is what you require?

hello sir a question, this expected dividend, what if the company doesn’t pay dividends, how does it work then. I just don’t understand how the dividend is a suitable figure for valuating share price since the CEO can just decide not to pay anything . are we talking about a set figure that is basically theoretical and may or may not be paid , who decides how much the dividend is? considering we want to retain some of our earnings for the growth of the business can the dividend be the rest minus pref shares divided by ord shares? how do we know ho wmuch we should keep for the company and how much we should distribute among shareholders as dividend?

For a quoted company, nobody would invest in shares if the company was never going to pay a dividend. They might pay no dividend for several years in order to grow but they must pay a dividend at some stage – the MV is the PV of the future expected dividends whenever they are expected to occur.

In addition (and more relevant for an unquoted company) the dividend valuation model is not the only way of finding a MV – there is an asset valuation and a PE valuation, both of which are explained in a later chapter.

I come from Asian country, not familiar with some different measurements were shown in the answer:
In example 1, the market value is 200c($2)
In example 5, the market value is 284p($2.84)
In example 8, the PV@8% is 125 (=$125 p.c. ex int.)
what are “c”, “p” and “p.c.” really stand for?

The growth formula gives the PV at time 0 when the first dividend is in 1 years time.

Here, the first growing dividend is in 3 years time, which is 2 years later than 1 years time, therefore the formula gives the PV two years later i.e. at time 2 instead of at time 0.

Oh my, I have watched this lecture three times now. I still don’t understand the last example and how we get to the solution. In particular the 189 baffles me – how can it be so high, when previous years were 20?

189 is the market value and is the PV of the future expected dividends. They will pay 189 for the share and will then expect to receive 20 per year for ever growing at 4% per year. They will obviously have to pay much more than 20 for the share – even if you were not expecting the dividends to grow, you would pay a lot more than 20 in order to then get income of 20 per year from your investment!!

In question no. 3 , there had been given ….. about to pay a dividend of 15c per share.
So, when we calculate market value, shouldn’t we get the cum div value of market value instead of market value( ex div)?

Because about to pay dividend refers to cum div market value, isn’t it?

I am also referring to question 7. I thought P in the formula is the market value of the shares and not the dividend? I would have expected that the market value of the dividend in 3 yrs time would be 20c X 1.04 = 20.8c. Why are we then discount the discount year 1 & 2 with the current value of the dividend and year 3 with the present value of the equity?

P in the formula is indeed the market value. 20.8 is the dividend in 3 years time, not the market value!!!
The market value, as I explain the lectures, is the present value of future dividends. Once the dividend starts growing, then we can use the formula to calculate the MV at that time. But everything then needs discounting to get the PV ‘now’.

You will know from the earlier lectures that the MV of the shares is the PV of the future dividends. 189 is the PV value of the dividends from time 3 onwards, but is a PV in 2 years time. To get the PV at time 0 we therefore discount for a further 2 years. We add this to the PV of the dividends at time 1 and time 2 and therefore get the total PV of the future dividends, which is the MV of the shares.

Hi I have question in example 7, the last one in the video. You discuss how after the two years of fixed dividends at 20c, we discount the 189c at the 2 year rate of 15% on the PV table (0.756).

I would have assumed we discount the amount for the 3rd dividends 189c at PV for 3 years at (0.658), would you mind explaining why this is done.

Because using the formula gives a PV now when the first dividend is in 1 years time.
When the first dividend is in 3 years time (which is 2 years later than in 1 years time), then the formula gives the PV in 2 years time (again 2 years later) and so needs discounting for 2 years.

Sir I understand but 1 confusion ,
but then why we use discount factor .756 for 2nd year dividend of 20c, why not .870. bcz its is 1 years later than in 1 years time

In one year, we’ll get 20c -which we discount at .870
In two years, we’ll get another 20c that year -which we discount at .756

However, after two years, the dividend will grow constantly forever/in perpetuity (So in the third year we get 4% more than a 20c dividend). -The PV of That^ at the end of the second year is 189c.

So we added that 189c to the 20c we receive in year 2 and discounted together at .756

JordanMcLoughlin says

Why is the discount rate for year two and year three is the same in example 7?

JojoBeat says

Hi Sir, when we use the dividend valuation model, are we getting the market value of the company as whole( Equity+Debt) or the market cap(equity only)?

John Moffat says

Equity only. That is why it is called the dividends valuation model, because dividends only go to equity.

JojoBeat says

So if we took the share price X no. of shares, would that mean we get the total market value of equity + debt or just equity?

JojoBeat says

Correction : The technical article says market value of co = future cash flows/WACC, so does that mean equity + debt since WACC includes both? Sorry for asking so many questions and thank you for being patient!

John Moffat says

The number of share multiplied by the share price is the total market value of the shares, which is the total market value of equity.

John Moffat says

The market value of shares is the PV of the dividends discounted at the cost of equity.

The PV of the operating cash flows (before interest) discounted at the WACC is the total market value of the company (equity + debt).

(Although this second statement is more relevant for Paper AFM)

No problem asking questions, although questions (as opposed to comments) are better asked in the Ask the Tutor Forum – I do not always see questions here, but I always see them and answer them in the Ask the Tutor Forum.

novakvsroger says

sir the required rate of return on equity is after tax for calculating mv

and why and cost of debt is taken before tax why?

John Moffat says

The required rate of return to shareholders is not after tax. Tax has no effect on the cost of equity.

When calculating the market value of debt we use the investors required rate of return (which is before tax) because it is the investors who determine the market value and they are not affected by company tax.

Have you watched the lectures on the valuation of debt?

JojoBeat says

Sir, is it right to say we’ve discounted the dividend growth in perpetuity to get present value at time 2 however we must discount it again to get present value in time 0?

John Moffat says

If the first dividend is at time 3, then what you have written is correct 🙂

JojoBeat says

So its also right to say that if we discounted 20(1.04) with 15% at time 3, it would’ve not have taken into account the future expected dividend beyond time 3?

John Moffat says

No it is not correct. If the dividend is growing in perpetuity then we use the dividend growth formula to get the present value at time 2. I actually explain and illustrate this in my lectures.

dennissherpa101 says

sir also Is it possible to forecast the market value in 1 years time 2 years time 3 years time and so on?

John Moffat says

Yes, and I explain this in my lectures. If dividends are expected to grow by (say) 5% a year, then the market value will also be expected to grow by 5% as year as well. Again, I explain why in the lectures.

dennissherpa101 says

sir when dividend are growing by 4% in year 1 will the dividend by 20*1.04 or will just be 20 and in 2 years time will be 20*1.04?

John Moffat says

It will be 20×1.04 at time 1, and will be 20 x 1.04^2 at time 2. Just as when inflating cash flows in NPV questions.

dennissherpa101 says

Sir why is it called the current market value? Does this represent the current market price or the price in which share should be bought if the given rate of return and the dividend is what you require?

dennissherpa101 says

** ps The terminology current market value confuses me since you mentioned it being future

John Moffat says

The market value changes from day to day. The current market value is the market value today.

dennissherpa101 says

is it the price quoted in the stock exchange.?

John Moffat says

Yes – the price quoted on the stock market/exchange (as I do explain in my free lectures!).

Tjmitch says

Alright, sir. Thanks a lot ?

John Moffat says

You are welcome 🙂

Tjmitch says

Hi Sir,

Please is there a way to use the dividend valuation model to calculate the price of a share if the company’s retention ratio is 100%?

By the way I must say I admire you a lot, Mr. Moffat, for the great skill with which you teach

Thank you very much for your hard work, sir

John Moffat says

See me reply to the previous question (below) 🙂

aniabagheri says

hello sir a question, this expected dividend, what if the company doesn’t pay dividends, how does it work then. I just don’t understand how the dividend is a suitable figure for valuating share price since the CEO can just decide not to pay anything . are we talking about a set figure that is basically theoretical and may or may not be paid , who decides how much the dividend is? considering we want to retain some of our earnings for the growth of the business can the dividend be the rest minus pref shares divided by ord shares? how do we know ho wmuch we should keep for the company and how much we should distribute among shareholders as dividend?

John Moffat says

For a quoted company, nobody would invest in shares if the company was never going to pay a dividend. They might pay no dividend for several years in order to grow but they must pay a dividend at some stage – the MV is the PV of the future expected dividends whenever they are expected to occur.

In addition (and more relevant for an unquoted company) the dividend valuation model is not the only way of finding a MV – there is an asset valuation and a PE valuation, both of which are explained in a later chapter.

nataliemcc says

Hi tutor

I come from Asian country, not familiar with some different measurements were shown in the answer:

In example 1, the market value is 200c($2)

In example 5, the market value is 284p($2.84)

In example 8, the PV@8% is 125 (=$125 p.c. ex int.)

what are “c”, “p” and “p.c.” really stand for?

John Moffat says

p.c. stands for ‘per cent’ (i.e. per 100)

‘c’ is the market price stands for ‘cent’ (there are 100 cents in one $).

‘p’ in the market price is a typing mistake – it should be ‘c’ for ‘cents’.

ankur1990 says

Hi sir,

in question 7, I got confused why don’t we use the discounting factor 0.658 for 3 years to calculate the PV

John Moffat says

The growth formula gives the PV at time 0 when the first dividend is in 1 years time.

Here, the first growing dividend is in 3 years time, which is 2 years later than 1 years time, therefore the formula gives the PV two years later i.e. at time 2 instead of at time 0.

KimR says

Hi John 🙂

Oh my, I have watched this lecture three times now. I still don’t understand the last example and how we get to the solution. In particular the 189 baffles me – how can it be so high, when previous years were 20?

John Moffat says

I assume that you are referring to example 7.

189 is the market value and is the PV of the future expected dividends. They will pay 189 for the share and will then expect to receive 20 per year for ever growing at 4% per year. They will obviously have to pay much more than 20 for the share – even if you were not expecting the dividends to grow, you would pay a lot more than 20 in order to then get income of 20 per year from your investment!!

KimR says

Thank you 🙂

John Moffat says

You are welcome 🙂

shram says

In question no. 3 , there had been given ….. about to pay a dividend of 15c per share.

So, when we calculate market value, shouldn’t we get the cum div value of market value instead of market value( ex div)?

Because about to pay dividend refers to cum div market value, isn’t it?

adeleyead says

I am also referring to question 7. I thought P in the formula is the market value of the shares and not the dividend? I would have expected that the market value of the dividend in 3 yrs time would be 20c X 1.04 = 20.8c. Why are we then discount the discount year 1 & 2 with the current value of the dividend and year 3 with the present value of the equity?

John Moffat says

P in the formula is indeed the market value. 20.8 is the dividend in 3 years time, not the market value!!!

The market value, as I explain the lectures, is the present value of future dividends. Once the dividend starts growing, then we can use the formula to calculate the MV at that time. But everything then needs discounting to get the PV ‘now’.

raheel95 says

However in this example we have discounted the dividend in 1 years and 2 years time (20c) and then the MV (18.9) from 2 years onwards.

Why do we not discount the MV for years 1 and 2 to be consistent with our approach with year 2 onwards?

Thanks

John Moffat says

The approach is 100% consistent.

You will know from the earlier lectures that the MV of the shares is the PV of the future dividends. 189 is the PV value of the dividends from time 3 onwards, but is a PV in 2 years time. To get the PV at time 0 we therefore discount for a further 2 years. We add this to the PV of the dividends at time 1 and time 2 and therefore get the total PV of the future dividends, which is the MV of the shares.

saritha1 says

Hi I just wanted to know why is the market value taken for yr3 and just the dividend in year 1 and year 2 while discounting?

Thanks in advance

John Moffat says

Which example are you referring to?

saritha1 says

example 7..

fatin123 says

Hi sir, i still don’t get it why for the example,the discount factor is 0.756 instead 0.658. Can you help me please with this. Thank you

dahawy says

Hi I have question in example 7, the last one in the video. You discuss how after the two years of fixed dividends at 20c, we discount the 189c at the 2 year rate of 15% on the PV table (0.756).

I would have assumed we discount the amount for the 3rd dividends 189c at PV for 3 years at (0.658), would you mind explaining why this is done.

Hope you understand my question 🙂

Really appreciate the help.

John Moffat says

Because using the formula gives a PV now when the first dividend is in 1 years time.

When the first dividend is in 3 years time (which is 2 years later than in 1 years time), then the formula gives the PV in 2 years time (again 2 years later) and so needs discounting for 2 years.

dahawy says

Thank you for your quick response 🙂

John Moffat says

You are welcome 🙂

Zeshan957 says

Sir I understand but 1 confusion ,

but then why we use discount factor .756 for 2nd year dividend of 20c, why not .870. bcz its is 1 years later than in 1 years time

Shivangi says

In one year, we’ll get 20c -which we discount at .870

In two years, we’ll get another 20c that year -which we discount at .756

However, after two years, the dividend will grow constantly forever/in perpetuity (So in the third year we get 4% more than a 20c dividend). -The PV of That^ at the end of the second year is 189c.

So we added that 189c to the 20c we receive in year 2 and discounted together at .756

manishatai says

Is the market price of a share the current price per share?

John Moffat says

Yes – it means the same thing, the price at which it is being traded on the stock exchange.

manishatai says

Thank you!

John Moffat says

You at welcome 🙂