Module 8 Capital Structure and an Introduction to valuations Flashcards
What are the four steps in the non-constant dividend growth model?
1) Calculate the present value (PV) of the dividends over year of non-constant growth
2) Value the shares at the end of the period using the new growth rate
3) Discount the share value calculated in (2) back to the present day
4) Add together the PV of all the dividends to get the share value
What is a redeemable preference share?
Would give you only a few years of [reference dividends before you would receive your capital back again at the redemption rate (which was specified when you invested)
What is a irredeemable preference share?
You invest a lump sum of capital, and receive preference dividends every year forever but never receive your lump sum back again
How do you value irredeemable shares and bonds?
P = S / r
Where:
S= the annual dividend or interest
r= the required yield (expressed as a percentage)
What is the cost of equity?
The cost of equity is the percentage return demanded by the owners or shareholders of the business
What does D in the cost of equity formula represent?
The most recently paid dividend
What is the formula for Ex Dividend price?
Ex-dividend price = Cum-dividend price - Dividend about to be paid
What is the Ex-dividend date?
The date from which anyone buying a share is not entitled to the recently announced dividend
What happens if a share is sold after the Ex-dividend date?
The dividend would go to the selling shareholder, with the purchaser gaining entitlement only to future dividends announced
The annual return to attract investors in the form of debt is lower vs equity. This is because:
- Investing in a firm via debt is less risk than investing in shares
- in the event of liquidation, shareholders will only receive any remaining money after the debt providers have been paid back in full
The cost of debt will be lower than the cost of equity as debt finance is cheaper for a company to obtain than equity for several reasons:
- The cost of raising debt finance is lower (bank arrangement fees and bond issuance costs are less than the costs of a share issue)
- The annual return to attract investors in the form of debt is lower
- The cost of interest is tax deductible, but dividends are not
What does 8% bond mean?
The interest paid on each bond is 8% of its £100 nominal value, or in other words £8
What are the assumptions in the Modigliani and Miller Gearing theory?
- Capital markets are perfect
- No taxation
- No transaction costs
- Individuals can borrow at the same rate as firms
- Home made gearing has the same risk as corporate gearing
