Equity Valuation

Question 1

Dividend Discount Model (Gordons Growth Model)

Answer 1

Used to calculate value of a
share

Gordon’s growth model
assumes that future dividends
grow at a constant rate

Dividend / ( return required - dividend growth )

Question 2

Price-earnings ratio

Answer 2

Used to provide an indication of
the value of a share

Indicates number of years
needed at current EPS to repay
share price (ignoring time value
of money)

Implied value of a share = PE ratio x expected EPS

Question 3

Shareholder value model

Answer 3

Used to establish whether a
company can add value for its
ordinary shareholders

Economic value added (EVA)

If result is positive - value is being added

If negative - value is being destroyed

Calculate by:

Adding back non cash items

Subtracting the companys weighted average cost of capital

Multiplied by an adjusted net assets figure (the invested capital)