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Hi Sir
I cannot understand the following sentences from the course notes.
“One way that we are able to estimate the likely cost of future equity finance is to look at the existing shares and determine what rate of return the shareholders are currently demanding.
We can do this for quoted shares by using the principle that the market value of a share depends on the future expected dividends and the shareholders required rate of return”.
Could you pls. explain this for me? I listened to the lectures but I still didn’t get it.
The market value of shares on the stock exchange is determined by shareholders – it is what they are prepared to pay.
In theory the market value is the present value of the expected future dividends, discounted at the rate of return they require.
If we know the current market value and we know what dividends the shareholders expect in the future, then we can calculate the return that they are requiring (and getting) on the existing shares. If the company is offering new shares then they are going to have to give shareholders the same return.
It will help you to watch the F9 lectures on the valuation of securities and on the cost of capital (because this part of P4 is all revision of F9).
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