Corporate Finance
Equity Valuation
Sources of Corporate Finance
❑Balance sheet of Apple (in billion (!) dollars)
Assets Liabilities
Property / Plant 40 Long-term Debt 162
Other Fixed Assets 177 Accounts Payable 55
Other current liabilities 70
Inventory 7 Total
Accounts Receivable 51 Equity
Cash 62 Common Stock 63
Other current Assets 14 Retained Earnings 1
Total Assets 351 Total Liabilities 351
The Financing Decision
Shares vs. Bonds
❑ Face value/par value - the original issue price (the amount
borrowed).
❑ Maturity date - date on which the loan has to be repaid.
❑ Coupon rate - original interest rate on the bond.
Shares vs. Bonds
❑ A share (or equity investment) is simply “part-
ownership in a company”
Share valuation
❑ How can we determine the value of a share?
❑ In principle, shares can be valued in exactly the
same way as bonds, and other financial assets.
We calculate the PV of all cash flows that the
investor will receive in the future.
❑ The expected cash flows to be received from a
share are all future dividends.
❑ Shares have no maturity, therefore we assume
that dividends go on forever, like a perpetuity.
D1 D2 D3
𝑃𝑠 = + 2
+ 3
+⋅⋅⋅
1+𝑟 1+𝑟 1+𝑟
Constant Growth Valuation
➢ What is the price of a share that is expected to pay an annual
dividend of $2.20 into the foreseeable future, if investors require a
rate of return of 10% p.a.?
𝐷
𝑃𝑠 =
𝑟
2.20
𝑃𝑠 =
0.10
𝑃𝑠 = $22
Preference Shares
❑ Preference shares are a special kind of shares.
❑ Shareholders of preferred stocks receive a fixed
dividend, before the ordinary shares receive
dividends.
❑ Dividends on preference shares are typically fixed
(constant).
❑ Preference shares can be valued as a perpetuity
Ordinary Shares
❑ Ordinary shares do not have a fixed dividend.
❑ The management of the company can decide to pay
a different amount of dividend each period.
Constantly growing dividends
❑ Many companies will try to maintain a stable dividend
growth rate, so that investors know what to expect.
Constant Growth Valuation
❑ When dividends grow at the same rate each period, the
share can be valued as a growing perpetuity.
❑ Constant growth formula:
𝐷1
𝑃𝑠 =
𝑟−𝑔
➢ 𝑷𝒔 - share price
➢ 𝑫𝟏 - dividend payment at the end of the first period
➢ 𝒈 - dividend growth rate.
➢ 𝒓 – required rate of return
Constant Growth Valuation
➢ A share just paid an annual dividend of $5/share. The dividend
payments are expected to grow at 10% per year, indefinitely.
Investors require a return of 14% for holding this type of stock.
What is the value of this share?
𝐶1
𝑃𝑠 =
𝑟−𝑔
5 × (1.10)
𝑃𝑠 =
0.14 − 0.10
𝑃𝑠 = $137.50
Constant Growth Valuation
➢ A stock just paid an semi-annual dividend of $3/share. The
dividend payments are expected to grow at 4% every half year for
the foreseeable future. Investors require a return of 14% p.a. for
this type of stock. What is the price?
D1
𝑃𝑠 =
𝑟−g
Get the semi-annual 𝑟: (1.14)1/2 = 1.0677
3 × (1.04)
𝑃𝑠 =
0.0677 − 0.0400
𝑃𝑠 = $112.64
Constant Growth Valuation
➢ National Beverage Corp is expected to pay an annual dividend of
$1.15/share by the end of this year. Dividend is expected to grow
at 3.4% p.a. indefinitely. Investors require a return of 8.2% p.a. for
this type of stock. What is the price?
D1
𝑃𝑠 =
𝑟−g
1.15
𝑃𝑠 =
0.082 − 0.034
𝑃𝑠 = $23.96
❑ What determines the required rate of return by
investors for holding a share?
❑ Again, investors’ 𝑟 is determined by:
Risk-free rate + Risk premium
Corporate Finance
Equity Valuation
Variable Growth Valuation
➢ A company has just paid an annual dividend of 15 cents per share
and that dividend is expected to grow at a rate of 20% per annum
for the next 3 years, then with 5% over the fourth year, and remain
constant at that same level forever after that. Assuming a
required rate of return of 10%, calculate the current market price
of the share.
0.18 0.216 0.2592 0.27216
…etc. →
T=0 1 2 3 4
❑ The future dividends of this share look like three single sum
cash flows + a perpetuity.
0.18 0.216 0.2592 0.27216
…etc. →
T=0 1 2 3 4
𝐹𝑉𝑛
❑ Single sums: 𝑃𝑉 =
(1+𝑟)𝑛
0.18 0.216 0.2592
𝑃𝑉 = 1
+ 2
+ 3
= 0.5369
(1.10) (1.10) (1.10)
𝐶
❑ Perpetuity: 𝑃𝑉 =
𝑟
0.2592 × 1.05
𝑃𝑉3 = = 2.7216
0.10
2.7216
𝑃𝑉0 = 3
= 2.0448
(1.10)
❑ Share Value = 0.5369 + 2.0448 = $2.58
Variable Growth Valuation
➢ A company has just paid an annual dividend of $1.50 per share
and that dividend is expected to grow at a rate of 15% per annum
for the next 3 years, and at a rate of 3% per annum forever after
that. Assuming a required rate of return of 7.4%, calculate the
current market price of the share.
1.725 1.984 2.281 2.350
…etc. →
T=0 1 2 3 4
𝐹𝑉𝑛
❑ Single sums: 𝑃𝑉 =
(1+𝑟)𝑛
1.725 1.984 2.281
𝑃𝑉 = 1
+ 2
+ 3
= 5.167
(1.074) (1.074) (1.074)
𝐶
❑ Growing perpetuity: 𝑃𝑉 =
𝑟−𝑔
2.281 ∗ 1.03
𝑃𝑉3 = = 53.40
0.074 − 0.03
53.40
𝑃𝑉0 = 3
= 43.11
(1.074)
❑ Share Value = 5.167 + 43.11 = $48.28
