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Tutorial 7: Equity Valuation

The document contains 7 questions regarding equity valuation. Question 1 has 5 parts regarding dividend growth stock valuation. Question 2 has 2 parts using the dividend discount model. The remaining questions cover required rates of return, P/E ratios, and using the dividend discount model to value stocks with changing growth rates.

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40 views11 pages

Tutorial 7: Equity Valuation

The document contains 7 questions regarding equity valuation. Question 1 has 5 parts regarding dividend growth stock valuation. Question 2 has 2 parts using the dividend discount model. The remaining questions cover required rates of return, P/E ratios, and using the dividend discount model to value stocks with changing growth rates.

Uploaded by

stella
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Tutorial 7

EQUITY VALUATION
1) Sweetone shares have just paid a dividend of
RM0.50. The dividend is expected to increase by 10%
every year for the foreseeable future. Required rate of
return on Sweetone share is 14% p.a. and the share are
currently selling for RM15.3 per share.
• a) Should you buy this share and why?
• b) Based on your answer in (a), will you buy the share if your cost of capital is 12% and
why?
• c) If dividend growth has just been re-estimated to be zero and everything else is the
same as part (a) above, what would be the new share price for Sweetone?
• d) If the latest 12-month earnings for Sweetone were RM0.90 per share, what is the
current P/E ratio based on the information provided in part (a) above?
• e) Given an estimated next year earnings for Sweetone is 11% higher than latest earnings,
what is the stock’s estimated value assuming P/E ratio remained constant to next year.
• A.) (0.5 x 1.1) / (0.14 – 0.10) = 13.75
• Should not buy the share because market value > intrinsic value.
• B) IV = (0.5 x 1.1) / (0.12 – 0.10) = 27.5
• Should buy the share because market value < intrinsic value.
• C) IV = 0.5 / 0.14 = 3.57
• D) P/E = P / EPS = 15.3 / 0.90 = 17x
• E) P = 17 x (0.9*1.11) = 16.98
• 2) Assume you are given the following information about the stock of BAT Bhd: -

• The company’s latest dividend of RM4 per share is expected to grow to RM4.32 next
year, RM4.67 in year 2 and RM5.04 in year 3. In addition, the price of the share is
expected to rise from RM56.5 (current price) to RM77.75 in 3 years.

• a) Given the dividend are expected to grow indefinitely at 8% p.a., use a 15%
required rate of return and dividend valuation model to find the value of the stock.
• a) IV = 4.32 / (0.15 – 0.08) = 61.71

• b) Assume that actual dividend in year 3 is RM5.04, the dividend growth rate stays
at 8% p.a. and the required rate of return stays at 15%. Use the DDM to find the
price of the stock at the end of year 3.
• b) IV = (5.04 x 1.08) / ( 0.15 – 0.08) = 77.71
3) The ordinary shares of Rasal Bhd have a market
price of RM10.5, following a recent dividend
payment of RM0.80 per share. Dividend growth has
averaged 4.5% per annum over the past 5 years. What
is the rate of return required by shareholders implied
by the current share price?

• P = D1 / (R – g)
• R = (D1 / P) + g

• R = [0.80 (1+0.045) / 10.5] + 4.5% = 12.5%


4) KLK Bhd common stock is selling at P/E of 15
times. The stock price is RM25. What were the
firm’s earning per share?

• P/E = P / EPS
• EPS = P / PE
• EPS = 25 / 15 = 1.67
5) Explain the relationship between the investor’s
required rate of return and the value of a security.

• There is an inverse relationship between an investor’s required rate


of return and the value of a security. As the required rate of return
increases, the value of the security decreases, and a decrease in the
required rate of return results in a price increase.
6) You are considering to invest in Burza share or Suza
share. Burza share is expected to pay a dividend of RM2 a
share at the end of the year and the dividend is expected to
grow at a constant growth rate of 8%. Suza share currently
has paid its dividend of RM2.50 a share and its dividend
growth rate is constant at 5%. Both shares have required
rate of return of 15%.

a) Calculate the intrinsic value for both Burza and Suaza


share.

b) Currently, the Burza share is selling at RM30 a share


whereas Suza share is selling at RM35 a share. Based on
your answer in part (a), what is your investment decision?
• a) Burza = 2 / (0.15 – 0.08) = 28.57;

• Suza = (2.50 x 1.05) / (0.15 – 0.05) = 26.25

• b) Not to buy any share as both IV < MV


7) YTL recently pay a dividend of RM1 per share. The dividends is
expected to grow at a rate of 25% p.a. for the next 5 years, after
which it is expected to grow at 7% p.a. The required rate of return for
this stock is 18%. What is the estimated price of the stock.
D0 1.00 1.00 (PV)

D1 (1.00 x 1.25) = 1.25 FV / (1 + r) n


= 1.25 / (1.18) 1 = $1.06

D2 (1.25 x 1.25) = 1.56 = 1.56 / (1.18) 2 = 1.12


D3 (1.56 x 1.25) = 1.95 = 1.95 / (1.18) 3 = 1.19
D4 (1.95 x 1.25) = 2.44 = 2.44 / (1.18) 4 = 1.26
D5 (2.44 x 1.25) = 3.05 = 3.05 / (1.18) 5 = 1.33

TOTAL PV value for first 5 $5.96


years
• Discount P5 back to its:
• PV = FV / (1 + k) n = 29.67 / (1.18) 5 = 12.97

• Add the dicounted P5 to the total PV value of 5 years dividends:


• P0 = 12.97 + 5.96 = $18.93

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