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FMA 101 Topic 5 – Share Valuation Assignment Answers

 

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FMA 101 Topic 5- LEARNING OUTCOMES

After completing this topic, you should be able to:

  • Distinguish between debt and equity capital and explain the rights, characteristics and features of both ordinary and preference shares and the concept of market efficiency.
  • Apply a variety of ordinary share valuation models to determine the value of an ordinary share.
  • Explain the book value, liquidation value and price/earnings (P/E) multiple approaches used for share valuation.
  • Explain how changes in expected return and risk can influence the value of an ordinary share.

 

READING FMA 101 Topic 5 –

Before continuing with this topic, please read the following:

  • Gitman et al. (2015: Chapter 7)

Please make sure that you also read this study guide carefully as it contains additional information that is not in the prescribed textbook.

 

DIFFERENCES BETWEEN DEBT AND EQUITY CAPITAL

The key concepts that you must focus on are:

  • Equity Capital
  • Debt Capital
  • Shareholders’ voice in the management of a company
  • Shareholders’ claims on income and assets
  • Non-maturity of equity
  • Tax treatment of dividends

You must be able to distinguish between debt and equity capital with specific reference to the extent of their influence on the management of a business, maturity of debt and equity finance, and the tax treatment of interest on debts versus dividends from share capital.

 

ORDINARY AND PREFERENCE SHARE CAPITAL

The key concepts that you must focus on are:

  • Ordinary shares
  • Preference shares

You are expected to have a thorough and in-depth knowledge and understanding of ordinary share capital and preference share capital.

You must be able to explain and discuss the following features of ordinary shares:

  • Ownership
  • Par value
  • Pre-emptive rights
  • Authorised and issued shares
  • Voting rights
  • Dividends
  • Issuing ordinary shares
  • Venture capital
  • Going public to sell shares
  • The role of the investment banker

Regarding preference shares, you must have an in-depth knowledge and understanding of the following:

  • What preference shares are
  • Par value and non-par value preference shares
  • Preference shareholders’ basic rights
  • Features of preference share capital

 

ORDINARY SHARE VALUATION

The key concepts that you must focus on are:

  • Market efficiency
  • The efficient-market hypothesis
  • Behavioural finance

You must be able to explain and discuss the following aspects of ordinary share valuation:

  • Market efficiency
  • The efficient-market hypothesis
  • The behavioural finance challenge

 

ORDINARY SHARE VALUATION MODELS

The key concepts that you must focus on are the:

  • zero-growth model
  • constant-growth model
  • variable growth model
  • free cash valuation model

The basic share valuation equation specifies that the value of an ordinary share is determined by the dividend paid on the share and the expected return on an ordinary share. The expected return is also referred to as the cost of equity.

To calculate the value of an ordinary share, you are required to have an in-depth knowledge of the following share valuation models and you must be able to critically discuss their relevance and perform the necessary calculations using given information:

  • The zero-growth model
  • The constant-growth model
  • The variable growth model
  • The free cash valuation model

You need to pay close attention to Example 7.3 that includes the calculation of the average growth rate of dividends. The procedure demonstrated and explained in this example is the same as the one explained and demonstrated in chapter 5 (Time value of money) of the prescribed textbook.

The prescribed textbook includes very detailed examples that both explain and demonstrate how each of the above share valuation models is applied to determine the value of an ordinary share. You need to study these examples thoroughly and be able to perform a similar analysis using the information provided.

You must be able to explain each of the following share valuation approaches:

  • The book value approach
  • Liquidation value
  • Price/Earnings multiples

 

DECISION-MAKING AND ORDINARY SHARE VALUE

The key concepts that you must focus on are:

  • expected return
  • risk

You must be able to explain how changes in the business environment can affect expected return and risk, and how changes in these two variables will affect the value of an ordinary share.

 

ADDITIONAL SOURCES TO ACCESS

Access the following websites to broaden your understanding of share valuation in the context of financial management:

  • Stock valuation methods. 2010. ABC Stock Investing. http://www.abcstockinvesting.com/stock-valuation.html, accessed 27 February
  • How is a company’s share price determined? https://www.investopedia.com/ask/answers/061615/how-companys-share- price-determined.asp, accessed 27 February 2020.

 

FMA 101 Topic 5 – SELF-ASSESSMENT EXERCISES

At the end of this chapter, there is a series of different self-test problems, warm- up exercises, problems and a more comprehensive case study. You should attempt to answer these questions, perform the calculations and use them to practise and re-enforce your learning and understanding. You may submit any of your answers to the lecturer for assessment and feedback.

SBS also shares copies of previous exam papers with you during the semester. The questions in these exam papers are very good examples of what you are expected to know and be able to do having studied and mastered the content of chapter 7 of the prescribed textbook and having followed the guidance provided in this topic.

 

 

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