Lecture 3 - Share Valuation

What is the nature of equity ownership?

• Temporary

• Permanent

• Periodic

• None of the above

What should a firm do when it does not have access to profitable investment opportunities?

• Hold on the cash indefinitely

• Return money to shareholders via dividends

• Increase employee salaries

• Throw a birthday party on a yatch

What does ownership in common shares in a company provide?

• Guaranteed dividends

• Voting privileges

• First claim on assets in bankruptcy

• Fixed interest payments

Which of the following has a maturity date at which principal is to be repaid?

• Bond

• Common shares

• Both bond and common shares

• Neither bonds and common shares

When valuing shares, the promised cash flows are

• Known in advance and consistent over time

• Known in advance but can fluctuate over time

• Not known in advance and can fluctuate over time

• Not known in advance but are consistent over time

How might a firm increase its share price?

• By always increasing the dividend payout

• By reducing the dividend payout and reinvesting in positive NPV projects

• By reducing investment in the business to increase dividend payouts

• By never paying dividends and always reinvesting in the business

Answer explanation

This only applies IF there are NPV positive opportunities.

How should a firm allocate its profits if it wants to maximise share price?

• Always pay out maximum dividends

• Always repurchase shares

• Reinvest in firm, particularly in projects with positive NPV

• keep the profits in low yield account

What is the Dividend Discount Model (DDM) used for?

• Valuing a company's debt

• Predicting a company's future dividends

• Valuing a company's stock

• Calculating a company's dividend payout ratio

The Dividend Discount Model is least appropriate for valuing stock of which kind of company?

• A mature, dividend paying company with stable growth

• A young tech firm that does not pay dividend

• A blue-chip company with a history of paying regular dividends

• A utility company with steady cash flows and dividends

Answer explanation

DDM is only useful valuation tool only if there are dividends being paid!

The alternative valuation methods would be more appropriate for these types of firm would be P/E ratios which compares the company's stock to its earnings per share or discounted cash flow model (DCF)

Alternatively, these firms can use Economic Value (EVA) - this methods estimates the firm's economic profit.

How is the dividend payout generally considered in terms of value activity?

• Value-creating activity

• Value destroying activity

• Value-neutral activity

• None of the above