The valuation of securities - The valuation of equity - ACCA Financial Management (FM)
58 Comments
M
Mirela·
Thank you for creating these videos! They are very clear but also entertaining. They make me feel as if I am in a real classroom.
J
John MoffatTutor·
Thank you for your comment :-)
J
J·
Why is the discount rate for year two and year three is the same in example 7?
J
JojoBeat·
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)?
J
John MoffatTutor·
Equity only. That is why it is called the dividends valuation model, because dividends only go to equity.
J
JojoBeat·
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?
J
JojoBeat·
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!
J
John MoffatTutor·
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.
J
John MoffatTutor·
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.
P
pallavi·
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?
J
John MoffatTutor·
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?
H
Hamza Lad·
Your course only briefly mentions the PE ratio and earnings yield. It was severely tested on the 2023 June exam, with roughly 5 questions in each part A&B.
Nonetheless, your lectures are excellent!
Your work has inspired me.........
J
JojoBeat·
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?
J
John MoffatTutor·
If the first dividend is at time 3, then what you have written is correct :-)
J
JojoBeat·
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?
J
John MoffatTutor·
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.
D
Dennis·
sir also Is it possible to forecast the market value in 1 years time 2 years time 3 years time and so on?
J
John MoffatTutor·
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.
D
Dennis·
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?
J
John MoffatTutor·
It will be 20x1.04 at time 1, and will be 20 x 1.04^2 at time 2. Just as when inflating cash flows in NPV questions.
D
Dennis·
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?
D
Dennis·
** ps The terminology current market value confuses me since you mentioned it being future
J
John MoffatTutor·
The market value changes from day to day. The current market value is the market value today.
D
Dennis·
is it the price quoted in the stock exchange.?
J
John MoffatTutor·
Yes - the price quoted on the stock market/exchange (as I do explain in my free lectures!).
T
Timothy·
Alright, sir. Thanks a lot ?
J
John MoffatTutor·
You are welcome :-)
T
Timothy·
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
J
John MoffatTutor·
See me reply to the previous question (below) :-)
A
Ania·
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?
J
John MoffatTutor·
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.
H
Hung·
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?
J
John MoffatTutor·
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'.
A
Ankur·
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
J
John MoffatTutor·
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.
K
Kim·
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?
J
John MoffatTutor·
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!!
K
Kim·
Thank you :)
J
John MoffatTutor·
You are welcome :-)
R
Ram·
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?
A
adeleyead·
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?
J
John MoffatTutor·
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'.
A
Adam·
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
J
John MoffatTutor·
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.
S
saritha1·
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
J
John MoffatTutor·
Which example are you referring to?
S
saritha1·
example 7..
F
fatin123·
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
D
dahawy·
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.
J
John MoffatTutor·
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.
D
dahawy·
Thank you for your quick response :)
J
John MoffatTutor·
You are welcome :-)
Z
Zeshan957·
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
S
Ster·
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
P
penelope·
Is the market price of a share the current price per share?
J
John MoffatTutor·
Yes - it means the same thing, the price at which it is being traded on the stock exchange.
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.
and why and cost of debt is taken before tax why?
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?
Nonetheless, your lectures are excellent!
Your work has inspired me.........
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
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?
'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'.
in question 7, I got confused why don't we use the discounting factor 0.658 for 3 years to calculate the PV
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!!
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?
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'.
Why do we not discount the MV for years 1 and 2 to be consistent with our approach with year 2 onwards?
Thanks
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.
Thanks in advance
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.
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.
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 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