PARt 2: VALUAtIoN, RISk ANd REtURN
kEY tERMS
ask price, 182
Australian Securities Exchange
(ASX), 181
bid price, 182
book value, 174
Chi-X Australia, 181
Clearing House Electronic Sub-
register System (CHESS), 181
comparable multiples
method, 174
dividends, 159
firm-commitment offering, 179free cash flow (FCF), 170
Gordon growth model, 164
initial public offering (IPO), 179
investment banks, 178
lead underwriter, 179
liquidation value, 173
negotiated offer, 179
oversubscribe, 180
prospectus, 180
proxy fight, 159
proxy statements, 159
residual claimants, 159residual income measure (RIM),
174
road show, 180
seasoned equity offering
(SEO), 179
Stock Exchange Automated
Trading System (SEATS), 181
underwrite, 179
underwriting spread, 179
variable growth model, 165
weighted average cost of capital
(WACC), 171
zero growth model, 163SELF-tESt PRoBLEMS
Answers to Self-test problems and the Concept review questions throughout the chapter appear on
CourseMate with SmartFinance Tools at http://login.cengagebrain.com.
ST5-1 Omega Healthcare Investors pays a dividend on its Series B preferred shares of $0.539 per quarter.
If the price of Series B preferred share is $25 per share, what quarterly rate of return does the
market require on this share, and what is the effective annual required return?
ST5-2 During 2014, McDonald’s Corporation increased its annual dividend to $US3.28 from $US3.12 in- This continued a long string of dividend increases. The company has paid a cash dividend
to shareholders every year since 1976, and has increased its dividend payments for 38 consecutive
years, including through the 2007–2010 global financial crisis. Suppose you want to use the
dividend growth model to value McDonald’s shares. You believe the dividend will grow at 5% per
year indefinitely, and you think the market’s required return on this share is 11%. Let’s assume that
McDonald’s pays dividends annually and that the next annual dividend is expected to be $US3.70
per share. The dividend will arrive in exactly one year. What would you pay for McDonald’s shares
right now? Suppose you buy the shares today, hold them just long enough to receive the next
dividend, and then sell them. What rate of return will you earn on that investment?
QUEStIoNS
Q5-1 How are preferred shares different from
ordinary shares?
Q5-2 How do you estimate the required rate of
return on a share of preferred shares if you
know its market price and its dividend?
Q5-3 The value of ordinary shares cannot be tied
to the present value of future dividends
because most companies don’t pay
dividends. Comment on the validity, or lack
thereof, of this statement.Q5-4 A common fallacy in share market
investing is assuming that a good company
makes a good investment. Suppose
we define a good company as one that
has experienced rapid growth (in sales,
earnings or dividends) in the recent past.
Explain the reasons why shares of good
companies may or may not turn out to be
good investments.