Ordinary shares are the most common class of share and are also known as the "equity capital" of the company. From Inland Revenue (http://www.inlandrevenue.gov.uk/manuals/svmanual/03/SVM03020.htm) ordinary shares have 4 main characters;
- The right to all profits remaining after the payment of any preference dividend and to whatever dividend is voted to them by the shareholders on the advice of the Board at a general meeting.
- Holders of these shares would hope to share in the prosperity of the company by way of increased dividends
- The right on liquidation to all surplus assets after the preference shareholders have been paid off
- The right to attend and vote at general meetings.
With these characters the company must valuate the shares to let the shareholders to know what the future holds for their dividends which are know as "the future cash flows that will accrue to ordinary shareholders" (Corrria et al. 2004, p. 6-9).
There are 4 valuation methods to calculate the value of the ordinary shares.
- Dividend Discount model
- Free Cash Flow Model
- Price Multiples (relative valuation)
- EVA discount model.
Dividend Discount Models
The dividend discount model (DDM) is a widely accepted stock valuation tool. The model calculates the present value of the future dividends that a company is expected to pay to its shareholders. It is particularly useful because it allows investors to determine an absolute or "intrinsic" value of a particular company that is not influenced by current stock market conditions.
Po = D1
... middle of paper ...
Book value per share= (Shareholders/ No of ordinary shares)
The Economic Value Added (EVA) Approach
EVA takes all capital sources into account when calculating the return required and therefore determines the value added, i.e. the shareholder value, as the ultimate objective of the company. And the theory behind it: companies need equity to grow. The better they can manage the capital available, the easier it is to obtain new capital for further growth. Firms calculate the EVA approach by using the formula given;
EVA= (Return on Capital- WACC) x Invested Capital
There are three reasons that using the EVA approach can lead to uncertainty;
_ Defining capital costs intentionally wrong (usually too high for some
_ Using EVA only in the upper management level
_ Investing too little in training of employees
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