STOCK MARKETS The stock market is the segment of the capital market in which corporations raise needed equity funds by issuing shares (Stock) to the investing

• STOCK MARKETS

• The stock market is the segment of the capital market in which corporations raise

needed equity funds by issuing shares (Stock) to the investing public.

• The markets consist of Primary market and Secondary market.

Methods of Issuing Shares

Public offer

Private Placement (via OTC)

Rights Issue

Bonus Issue

1Prepared by Alhaj Nuhu Abdulrahman

CHAPTER 6: THE STOCK MARKETS AND STOCK VALUATION

Public Issue (offer)

• Public issue refers to the issuing (selling or offering) of shares by a company to the

general public.

• If the issue is the first time it is known as Initial Public Offer (IPO).

• If the issue is not the first time it is called additional or secondary issue.

• The Company making the offer must meet the requirements of the Capital Market

Regulatory Agency (SEC), and Ghana Stock Exchange (GSE).

• Prospective investors must be provided with detailed information about the

company’s line of business, the purpose of issuing the security and current financial

conditions in a document called prospectus.

• The preparation of the prospectus is done with the help of an issuing house called

Investment Bank appointed by the company.


STOCK MARKETS

Private Placement

• Private placement is the issue of securities to few identified institutional investors

such as Pension Funds, Insurance Firms, and Mutual Funds as well as other

companies and rich individuals.

• A private placement does not have to be registered with the SEC, but still needs to

present prospectus to prospective investors.

• Private placements are however more common in the sale of bonds than for shares.

Rights Issue

• This refers to the issue of additional shares to only existing shareholders of a

company. Each shareholder is issued rights to buy a specified number of additional

shares for each current holding (e.g. 3-to-1) at a specified price within a specified

time.


STOCK MARKETS

• To execute a right offering the issuing company must first determine the price of

the additional issue and then find answers to the following questions;

How many shares should be sold?

How many rights should each shareholder have to buy one additional share?

What will be value of each right

What is the likely effect of the rights offer on the value of existing shares?

Illustration:

A Corporation has 300,000 existing shares with current market price of GH¢1.50 each.

The company plans to raise additional GH¢90,000 through rights issue at a set price of

GH¢1.20 each. Determine;

1. How many new shares should be issued to raise the amount?

2. How many rights will be required to purchase additional shares?

3. What will be the value of each right?

4. What is the effect of the issue on the current market price of existing shares?


STOCK MARKETS

Solution

1.Number of new shares to issue = = = 75,000 shares

2. Number of rights to buy one new share = = 4:1 shares

3. Value of a right = = = GH¢0.06

4. Effect of rights issue on market price =

= = GH¢1.44 per shareThe price per share has fallen from GH¢1.50 to GH¢1.44.


STOCK MARKETS

Bonus Issue:

• Bonus issue represents additional shares distributed to existing shareholders of a

company in place of cash dividend, in proportion to their current holdings.

• Bonus issues under Ghana’s Companies code, is called capitalization issue.

• Types of shares (stocks)

Ordinary Shares: Ordinary shares represent part-ownership of a corporation. The

holder is entitled to yearly dividend which varies and can only recover the

investment by selling the shares in the secondary market through the intermediation

of a stockbroker on the floor of the Stock Exchange.

• Preference Shares: Preference shares represent part-ownership yet have no voting

rights and holders receive a specified yearly fixed dividend. Preference shares have

priority on ordinary shares in the payment of dividends.


STOCK MARKETS

• Types of preference shares

Cumulative or non-cumulative preference shares

Redeemable or irredeemable preference shares

Convertible non-convertible preference shares


STOCK MARKETSPreference Shares

Stock Valuation Models

Unlike bonds, stocks are more difficult to value due to the following reasons:

The promised cash flows (dividends) are not known in advance with certainty.

The investment has no maturity.

Difficult to know the market required rate of return.

• Thus, stock valuation is done based on forecasts and some assumptions.

• The most illustrated stock valuation method is; the dividend discount method.

• The method requires the application of present value of future cash flows discussed

earlier.


STOCK MARKETS

The dividend discount valuation methods

• Three theoretical assumptions exist under this model

Zero growth rate

Constant growth rate

Non-constant (Multiple) growth rate.

i) Zero Growth Model: This model assumes that dividend is not expected to grow

and the investment period is perpetual that is forever. Thus, Vo = , called

dividend growth model.

Illustration

• ABC company has just paid dividend of GH¢0.15 per share and has no intention of

reviewing it up for the coming years, what will be the value of the shares if the

required rate of return is 12%?


Stock Valuation Models

• Value (price) of the share should be; Vo = = = GH¢1.25 per share

• Example of this is the irredeemable preference shares which has constant dividend

and zero-growth.

• Because the dividend is the same into the future it is viewed as ordinary perpetuity.

ii) Constant Growth Model: This model assumes that dividends each year will grow

at a constant rate indefinitely, so called a “growing perpetuity” .

Vo = = called dividend growth model

• Where Do is current year’s dividend, g is growth rate and r is required rate of

return.

• So if ABC company revised its dividend policy to increase its dividend payment at a

constant rate of 5% and required return rate is still 12%, what will the value of the

company?


Stock Valuation ModelsThe dividend discount valuation methods

D1 = Do (1 + g)t

D1 = 0.15(1.05)1 = GH¢0.16

Vo = = GH¢2.29

Based on the above dividend policy,

(1) What will the dividend be in five years?

(2) What will the price be in five years?

(3) What will be the present value (price) based on the five-year forecasted price?

Solution(1) D5 = D0 x (1 + g)5 = 0.15 x (1.05)5 = GH¢0.19 per share

(2) P5 = = = = = GH¢2.86



(2) continues

OR P5 = = = = GH¢2.86.

The 5th year price will now be discounted to get today’s price (Po).

(3) Po= = = = GH¢1.62

iii) Variable Growth Model

• Firms normally experience different growth phases along the path of their business

life- cycles.

• The variable growth model therefore incorporates periods of increasing and stable

growth rates.



Illustration;

• UPS Ltd paid dividend of GH¢0.50 per share last year and expect it to grow at the

rate of 12% per annum for the next 3 years (supernormal growth) and to grow at a

steady rate of 7% per annum (normal growth) after the 3rd year into the future.

Investors’ required rate of return is however 15%. What should be the value (price)

of the company’s shares today?

Solution:Pattern of yearly dividend payments:Do = 0.50

D1 = 0.50(1.12) = 0.56

D2 = 0.56(1.12) = 0.63

D3 = 0.63(1.12) = 0.71

D4 = 0.71(1.07) = 0.76



Vo =

But V3 = = = 9.50

Thus; Vo =

=

= 0.49 + 0.48 + 0.47 + 6.25

= GH¢7.69



END OF CORPORATE FINANCE (PBBA 405)

END OF CORPORATE I (PBBF 305)

CORPRATE FINANCE II (PBBF 306) to continue next semester


END OF SEMESTER


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STOCK MARKETS The stock market is the segment of the capital market in which corporations raise needed equity funds by issuing shares (Stock) to the investing