AFMP4
Syllabus B. Advanced Investment Appraisal B4. Valuation and the use of free cash flows

B4a. Dividend Valuation 6 / 11

Syllabus B4a)

Apply asset based, income based and cash flow based models to value equity. Apply appropriate models, including term structure of interest rates, the yield curve and credit spreads, to value corporate debt.

Essentially this model presumes that a share price is the PV of all future dividends

Calculate this (with or without growth) and multiply it by the total number of shares

It is similar to market capitalisation except it doesn’t use the market share price, rather one worked out using DVM

DVM can be with or without growth.

DVM without Growth

Note:

  • Cost of Equity will be given, or calculated via CAPM

  • Take this share price and multiply it by the number of shares

DVM with growth

Note:

  • Dividend + growth = Dividend end of year 1

Share Capital (50c) $2 million
Dividend per share (just paid) 24c
Dividend paid four years ago 15.25c
Current market return = 15%
Risk free rate = 8%
Equity beta 0.8

Solution 
Dividend is growing so use DVM with growth model:

Calculating Growth 
Growth not given so have to calculate by extrapolating past dividends as before:

24/15.25 sq root to power of 4 = 1.12 = 12%

So Dividend at end of year 1 = 24 x 1.12

Calculate Cost of Equity (using CAPM) 
8 + 0.8 (15-8) = 13.6%

So using DVM with Growth model
Dividend + growth / Cost of Equity - growth (decimal)

Share price = 24x1.12 / 0.136 - 0.12 = 1,680c

Market cap = $16.8 x (2m / 0.5) = $67.2