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After studying this chapter you will be able to understand: To develop a model for the valuation of shares and bonds, to use this model to estimate the cost of equity and the cost of debt, to consider further practical influences on the valuation of securities. | Investment Analysis Lecture: 14 Course Code: MBF702 Outline RECAP DIVIDEND VALUATION MODEL - CONTINUE COST OF EQUITY COST OF PREFERENCE SHARES Objectives - RECAP To develop a model for the valuation of shares and bonds. To use this model to estimate the cost of equity and the cost of debt. To consider further practical influences on the valuation of securities. Elements of cost of capital - RECAP DIVIDEND VALUATION MODEL The theoretical model - RECAP The model then becomes: If the dividend is assumed to be constant this is a perpetuity that simplifies to: DIVIDEND VALUATION MODEL The theoretical model This model can then be used to determine the ex-div market value of a share with a constant dividend each year given the assumptions upon which the model is based. With growth If dividends are forecast to grow at a constant rate in perpetuity, where g = growth rate DIVIDEND VALUATION MODEL The theoretical model Assumptions behind the dividend valuation model rational investors all . | Investment Analysis Lecture: 14 Course Code: MBF702 Outline RECAP DIVIDEND VALUATION MODEL - CONTINUE COST OF EQUITY COST OF PREFERENCE SHARES Objectives - RECAP To develop a model for the valuation of shares and bonds. To use this model to estimate the cost of equity and the cost of debt. To consider further practical influences on the valuation of securities. Elements of cost of capital - RECAP DIVIDEND VALUATION MODEL The theoretical model - RECAP The model then becomes: If the dividend is assumed to be constant this is a perpetuity that simplifies to: DIVIDEND VALUATION MODEL The theoretical model This model can then be used to determine the ex-div market value of a share with a constant dividend each year given the assumptions upon which the model is based. With growth If dividends are forecast to grow at a constant rate in perpetuity, where g = growth rate DIVIDEND VALUATION MODEL The theoretical model Assumptions behind the dividend valuation model rational investors all investors have the same expectations and therefore the same required rate of return perfect capital market assumptions, for example − no transactions costs − no individual can affect the share price − all investors have all available information dividends are paid just once a year and one year apart dividends are either constant or are growing at a constant rate. Using the dividend valuation model The model in its most simple form (with constant dividends) can be used to estimate the theoretical fair values of shares. DIVIDEND VALUATION MODEL The theoretical model ILLUSTRATION Suppose that a share has a current ex-div market value of 80 pence and investors expect a dividend of 10 pence per share to be paid each year as has been the case for the past few years. Using the dividend valuation model the required return of the investors for this share can be determined: DIVIDEND VALUATION MODEL The theoretical model ILLUSTRATION Investors will all require this return from this share as they
