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Business valuations and market efficiency

Question 5

DVM valuation

A company has the following information available:

Share capital in issue: 1 million ordinary shares at a par value of $1.

Dividend just paid: $0.20 per share.

Current earnings per share (EPS): $0.25.

Current return earned on assets: 15%

Current equity beta: 1.2

Average market return on shares: 14%

Risk free rate: 4%

Calculate the market capitalisation of the company.
Market capitalisation = number of shares in issue × market price per share.

P 0 = D 0(1 + g)/(ke – g)
Ke = Rf + β(Rm – Rf)

Ke = 4 + 1.2 × (14 – 4) = 16%
g = b × r e

b = ($0.25 – $0.20)/$0.25 = 0.2

g = 0.2 × 0.15 = 0.03 or 3%

P 0 = ($0.20 × 1.03)/(0.16 – 0.03) = $1.58 per share

Market capitalisation = $1.58 × 1m = $1.58m

Illustrations and further practice

Now try TYU questions 4 and 5 from Chapter 20.

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