1. 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

2. 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. 2Prepared by Alhaj Nuhu Abdulrahman STOCK MARKETS

3. 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. 3Prepared by Alhaj Nuhu Abdulrahman STOCK MARKETS

4. 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? 4Prepared by Alhaj Nuhu Abdulrahman STOCK MARKETS

5. 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 share The price per share has fallen from GH¢1.50 to GH¢1.44. 5Prepared by Alhaj Nuhu Abdulrahman STOCK MARKETS

6. 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. 6Prepared by Alhaj Nuhu Abdulrahman STOCK MARKETS

7. Types of preference shares  Cumulative or non-cumulative preference shares  Redeemable or irredeemable preference shares  Convertible non-convertible preference shares 7Prepared by Alhaj Nuhu Abdulrahman STOCK MARKETS Preference Shares

8. 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. 8Prepared by Alhaj Nuhu Abdulrahman STOCK MARKETS

9. 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%? 9Prepared by Alhaj Nuhu Abdulrahman Stock Valuation Models

10. 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 D o 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? 10Prepared by Alhaj Nuhu Abdulrahman Stock Valuation Models The dividend discount valuation methods

11. D 1 = D o (1 + g) t D 1 = 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)D 5 = D 0 x (1 + g) 5 = 0.15 x (1.05) 5 = GH¢0.19 per share (2)P 5 = = = = = GH¢2.86 11Prepared by Alhaj Nuhu Abdulrahman Stock Valuation Models The dividend discount valuation methods

12. (2) continues OR P 5 = = = = GH¢2.86. The 5 th year price will now be discounted to get today’s price (P o ). (3) P o = = = = 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. 12Prepared by Alhaj Nuhu Abdulrahman Stock Valuation Models The dividend discount valuation methods

13. 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 3 rd 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: D o = 0.50 D 1 = 0.50(1.12) = 0.56 D 2 = 0.56(1.12) = 0.63 D 3 = 0.63(1.12) = 0.71 D 4 = 0.71(1.07) = 0.76 13Prepared by Alhaj Nuhu Abdulrahman Stock Valuation Models The dividend discount valuation methods

14. Vo = But V3 = = = 9.50 Thus; Vo = = = 0.49 + 0.48 + 0.47 + 6.25 = GH¢7.69 14Prepared by Alhaj Nuhu Abdulrahman Stock Valuation Models The dividend discount valuation methods

15. END OF CORPORATE FINANCE (PBBA 405) END OF CORPORATE I (PBBF 305) CORPRATE FINANCE II (PBBF 306) to continue next semester 15Prepared by Alhaj Nuhu Abdulrahman END OF SEMESTER

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