VALUATION OF ORDINARY SHARES
The ordinary/equity shareholders buy/hold shares in expectation of periodic cash dividends and an increasing share value. They would buy a share when it is undervalued (i.e. its true value is more than Its market price) and sell it when its market price is more than its true value (i.e. it is overvalued). The value of a share is equal to the present value of all future dividends it is expected to provide over an infinite time horizon. Symbolically,
where P= value of shares
D1 = per share dividend expected at the end of year, t
K1 = required return on share
The equation is designed to compute the value of shares with reference to the expected growth pattern of future dividends and the appropriate discount rate. We illustrate below the computation of value of shares with reference to (i) zero growth, (ii) constant growth and (iii) variable growth.