Valuation OF Securities PDF

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CAPITAL COLLEGE OF ACCOUNTANCY & MANAGEMENT FINACIAL MANAGEMENT CPA P10 TOPIC: VALUATION OF SECURITIES

Ordinary shares/Common stock Ordinary shares are shares that represent a normal equity ownership in a company. These shares often allow the investor to vote, to receive dividends, and to receive distributions on the winding up of a company. Features of ordinary shares/Common stock        

No fixed financing obligations No fear of funds outflows; i.e they are irredeemable No tax deduction expense. In case of dividends paid to shareholders, the expense is not tax deductible as compared to bonds. High floatation costs Claim on assets. Equity shareholders have a residual claim on the ownership of assets. Voting rights. Equity shareholders are the real owners of the company. They have a voting right in the working of the company. Pre-emptive rights, as when a public limited company wants to issue fresh equity shares, they are to be offered first to the existing shareholders. Limited liability. The liability of the equity shareholders is limited to the face of the shares.

Example one Toto Ltd is a company listed on the USE. The company has recently released its financial statements and is proposing to pay a dividend of UGX.3,000 per share. The company’s shareholders are known to have required rate of return of 10% on their investment. The company has been paying a dividend of UGX.3,000 per share for the last five years and this policy is not expected to change. The company has 10,000 shares in issue. Required: Using the above information, estimate the price at which Toto’s shares should be trading on the USE and the respective market capitalization of the company.

CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

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Example two XYZ ltd is a company listed on the USE. The company has recently released its financial statements and is proposing to pay dividends of UGX. 4,000 per share. This level of dividends represents a growth rate of 3% in the company’s earnings. The company’s shareholders are known to have required rate of return of 10% on their investments. Required: Estimate the price at which the company’s share should be trading on the USE. Example three ABC ltd is a company listed on the USE. The company has recently declared and paid a dividend of UGX. 3,000 per share. This level of dividends represents a growth rate of 3% in the company’s earning. The company’s shareholders are known to have a required rate of return of 10% on their investments. Required: Estimate the price at which the company’s share should be trading on the USE Example four Bat valley is a company listed on the USE. The company has recently declared and paid a dividend of UGX. 3,000 per share. The dividend is expected to be paid in the next three weeks. This level of dividends represents a growth rate of 3% in the company’s earnings. The company’s shareholders are known to have required rate of return of 10% on their investments. Required: Estimate the price at which the company’s share should be trading on the USE Example five Vision has been listed on the NSE for the last five years. The performance over the years has been as follows; Years

PAT Shs ‘million’

Total dividend Shs ‘million’

2013 2014 2015 2016 2017

800 840 920 975 1010

320 336 368 390 404

CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

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The company has one million shares in issue and has recently declared the dividend for the year 2017. The company’s shareholders have an expected return on investment of 24%. Required: Estimate the price at which its shares should be trading assuming the company maintains its dividend pay out ratio. Example six Nice company has a dividend payout ratio of 37.5% while the expected yield on retained earnings is currently at 24%. The company has recently declared a dividend of Ush. 750 per share. This is expected to keep growing in future based on current performance. Required: Estimate the company’s market price per share if it maintains its performance level. CUM-DIV & EX-DIV SHARE PRICES Dividends are paid periodically on shares. During the period prior to the payment of dividends, the price rises in anticipation of the payment. At this stage, the price is CUMDIV. Sometimes after the dividend is declared the share becomes EX-DIV, and the price drops. If the dividend is just about to be paid on a share, an investor buying the share CUM-DIV is entitled to the dividends. An investor buying the share EX-DIV is not entitled to the dividend. The seller of shares receives the dividend. Example seven A share is quoted cum-div at Shs. 450. The dividend has just been declared at Shs. 50 What is the probable ex-div price? Example eight A share is quoted cum-div at Shs. 450. The dividend to be declared is expected at Shs.50 What is the probable ex-div price? Preference shares A share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends (Ordinary shareholders) Features of Preference shares Claims on income and assets. Preference share is a senior security compared to equity shares. Dividends are to be paid on preference share before payment on equity. Fixed dividends. The dividend rate is fixed in the case of preference shares. No voting rights. However, they have a right to vote on matters that affect them. CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

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Maturity. They are irredeemable. i.e they are perpetual They are a hybrid for of security. Example nine Satelite is a company that has listed its financial securities on USE. These include both ordinary and preference shares. The preference shares have a face value of Ush. 1,000 per share and pay a dividend of 8%. These are expected to be redeemed in five years+’ time at a redemption value of Ush. 1,200 per share. The company’s preference shareholders have a required rate of return of 10%. Required: estimate the market price of bob wine’s preference shares. Example ten Wine has in issue 12% preference shares with a par value of Shs. 2,000 per share. The company’s shareholders have a required rate of return of 10%. Required: Estimate the current market price of the company’s preference shares.

Bond/ Debenture A bond is a long-term debt instrument. A long-term security yielding a fixed rate of interest, issued by a company and secured against assets Features of a bond/ Debenture Features of a bond include but not limited to: a) Face value. Face value is a par value. A bond is always issued at par value of Shs. 100, and interest is paid on the face book. b) Coupon Interest rate. The interest rate is fixed and known to the bondholders. The interest paid to bondholders is tax deductible. c) Maturity. A bond / debenture is usually issued for a specified period of time. It is paid on time. d) Redemption value. The value that the bond holder will get on maturity is called redemption or maturity value. A bond maybe redeemed at par, discount or at a premium. e) Market value. A bond maybe traded on stock exchange. The price at which it is currently sold or bought is called the market value. f) They are either secured or not g) Debenture holders have a claim on the company’s earning prior to that of shareholders on liquidity. CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

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Example eleven Capital college has in issue a 12% bond redeemable in 5 years’ time. Market interest rates are currently at 10% while the coupon interest is paid on a quarterly basis. Required: i. ii.

Estimate the market price of the bond Esitimate the effective interest rate of the bond

Example twelve Bobi has in issue a 12% debenture redeemable in 3years’ time at par. The interest on a debenture is paid semi-annual, market interest rates are at 10%. Required: Estimate the market price of the debenture.

CPA P10 Question 4 (a)- MAY 2017: (10 marks) (a) The Bank of Uganda issued a five-year treasury bond in the primary market with a coupon rate of 10.5%. An investor, who requires a maturity value of Shs 10 million from this bond, bided for it. Required: i.

Determine the price of the bond if the desired yield to maturity is 15%. (5 marks)

ii.

Compute the yield to maturity of the bond on the secondary market, after the expiry of the offer period in the primary market, given that the same bond is now being traded on Uganda Securities Exchange (USE) at Shs 9 million. (5 marks)

CPA P16 Question 4- MAY 2018: (25 marks) The management of Kampala Knitters Ltd (KKL) is in the process of acquiring new equipment for the manufacture of polo shirts in the medium to long-term. They are, therefore, preparing to hold their money in investments that will store their value securely; and a variety of proposals have been considered and shared with the members of board of directors. The chairman of the board of directors recently attended a meeting where warrants and traded options were extensively discussed. Based on this new information, he suggests that debt instruments accompanied by either attached warrants or traded options might be attractive and also have substantial benefits. However, the CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

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finance director is of the view that they should put more time in reviewing KKL’s potential to invest in long-term bonds. Currently, there are two bonds (A and B) available on the securities exchange that KKL would need to consider: Security A: The market value of a Shs 100 million per value bond carrying a coupon rate of 14% which is expected to mature in 5 years is Shs 105 million.

Security B: A Shs 100 million par value bond bears a coupon rate of 14 %; matures after 5 years; interest is paid semi-annually and the required rate of return is 16%.

Required: (a) Discuss the viability of the chairman’s suggestion in KKL’s context. (8 marks) (b) Estimate the: i.

yield to maturity of Security A.

(7 marks)

ii.

value of Security B.

(3 marks)

(c) Advise the management of KKL on the factors they should consider before investing in bonds.

(7 marks) (Total 25 marks)

RIGHTS ISSUE A rights issue is where shares are offered to existing shareholders in proportion to their current shareholding usually at a discount. (At a price lower than the current share price). Calculating the market price of shares after a rights issue  The price at which the existing shareholders purchase the shares is called offer price  Shares are said to be selling CUM-right between the periods of announcements and implementing the issue.  Once the rights issue has taken place and shareholders have bought the shares, the shares are said to be selling EX-right.  The amount of capital raised from a rights issue will depend on the offer price and the number of shares issued.

CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

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New Capital = Offer price x number of shares issued  After the issue has been made, the market price will normally fall because there are more shares in issue and the new shares were at a discounted price. This is referred to as THEORETICAL EX-RIGHTS PRICE (TERP).  TERP is the weighted average price based on the market value of the existing ordinary capital and the capital raised.  It assumes that all rights are exercised on a single day.

TERP = Market value of shares prior to the rights issue + Cash raised from rights issue Number of shares after the rights issue

VALUE OF A RIGHT The right to buy a new share is attached to the shares currently being held. For instance, a shareholder with 1000 shares has 1000 rights. The number of rights required to buy a new share is expressed by the relation between the existing ordinary shares and the new shares issued.

Number of rights = Existing Number of ordinary shares New shares issued A right is separable from shares to which it is attached. Thus, an investor can sell the right without selling the share. The value of a right is the theoretical gain an investor would make by exercising his right. Value of rights per existing shares = CUM-right – TERP

The value of a right = New Price (TERP) – offer price Number of rights of a share On announcement of the rights issue, the shareholder has the option to exercise the rights, sell the rights, exercise part of the rights or ignore the rights.

CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

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Benefits of a Rights issue  Rights issue may be used to reduce the level of gearing and financial risk without retiring the existing debt.  The relative voting right and ownership of the company is not diluted since the shares are issued to existing shareholders.  The issue of more ordinary share capital will reduce gearing of the company, similar capital raised may be used to pay off long term debt.  It involves less administrative procedures compared to an initial public offer.  It involves lower floatation costs compared to an initial public offer  It benefits existing shareholders who are able to acquire more shares at a discount.

Disadvantages of a rights issue  The issue will need to be priced at a discount to the current share in order to make it attractive  If the rights issue is not successful, a significant number of shares may be taken by the underwriters thus changing the voting structure.  The administration and underwriting costs are always too high. Example thirteen Mukwano has issued capital of 20 million shares and has a current market value of Shs. 27 per share. The company makes a rights issue of one new shares for every two existing shares at a price of Shs. 21 per share. Required: Compute TERP Example fourteen Equity has in issue 100,000 shares currently trading at Shs. 2,000 per share. The bank needs to raise an additional capital of Shs. 75,000,000 and is considering raising this through a rights issue. The rights issue proposed is a one per every two shares held by each shareholders at a discount of 25%. The bank has 4 shareholders each with 40%, 30%, 20% and 10% shareholding respectively. Required: a) b) c) d)

What price will shareholders have to pay for each share? How many shares will be raised in the rights issue? What is the TERP of the shares assuming all shareholders exercise their rights? What is the value of the rights attached to each share currency?

CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

CPA BUDALAH NSUBUGA: 0775581435/0700189530

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CPA P10 Question 3- November 2018: (20 marks) Sendi Uganda Ltd (SUL) deals in the importation and installation of solar equipment in areas where the national electricity grid does not reach. The company won a tender to supply and install solar power in the 10 districts in west Nile region. To effectively carry out this work, SUL requires additional funds worth Shs 1 billion and the directors intend to raise the required funds from an issue of ordinary shares either to the general public or by using rights. The finance director advised the directors to raise the funds required through a rights issue offer, reasoning that issuing shares to the general public dilutes control, and the directors seem to be in agreement. SUL has in issue 1 million ordinary shares currently selling at Shs 2,000 per share. The company requires Shs 1 billion to be raised from a rights issue offering. For the process to be successful, shares will be issued at a discount of 20% of their market price. Required: a) Calculate the: i. ii. iii.

theoretical ex-rights price.

(5 marks)

value of a right.

(2 marks)

new market value of the company.

(3 marks)

b) Explain to the Board of SUL the following: i.

Pre-emptive rights.

(2 marks)

ii.

Subscription rights.

(2 marks)

iii.

Initial public offering (IPO).

(2 marks)

iv.

The importance of the underwriter in issuing shares to the general public. (4 marks)

CAPITAL COLLEGE NOTES CPA P10 JUNE 2020

(Total 20 marks)

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