Lecture 3 - FINM7006.pptVIP

* * * * * * * * * * * * * * * * * * * * * * * Foundations of FinanceLecture 3 The Time Value of Money: Valuing Shares Lecture Readings: Foundations of Finance pp. 100-120 (omit: bond valuation, pp. 106-109, inclusive, and, bond holders’ expected rate of return, pp. 116 117). pp. 169-191 (omit: dividends versus investment and growth, pp. 178-181, but read changing growth rates on pg. 181. Also omit: share repurchases and the total payout model, pp. 186 187). 1. Lecture Overview In the coming weeks, we are going to apply the time value of money concepts from last lecture to valuing financial instruments. In doing this, we will see that the value of any asset can be calculated simply by finding the present value of all its cash flows. This week, we are going to apply the time value of money idea to valuing shares. 1. Lecture Overview In discussing how to calculate the value of a share, we will consider the following important related issues: What are the differentiating features of the corporation as a form of business organization? What are shares in a corporation?; What characteristics do shares exhibit?; What cash flows are associated with shares?; How do we go about calculating the value of a share?; and, What is the difference between the price and the value of a share? 2. The Corporation The corporation differs from other forms of business organization in 3 important ways: Ownership is usually widely dispersed; Shareholders have no right to be involved in the daily running of the corporation; and, Shareholders have limited or no liability for the liabilities incurred by the corporation. We will now discuss each of these characteristics in greater detail. 2.1 Characteristics of the Corporation Wide Dispersion of Ownership: It is important to note the following in relation to the ownership of a corporation: Ownership of the corporation is generally widely dispersed among numerous “shareholders”; Ownership in the corporation can be easily transferred