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Lecture_3_-_The_Time_Value_of_Money_-_Valuing_Shares - 1...

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Money Markets and Finance Lecture 3 The Time Value of Money: Valuing Shares 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 between different shareholders (NB: this transfer DOES NOT raise any additional funds for the corporation); and, • Ownership can be transferred between shareholders without interfering with the operation of the corporation itself. 2.1 Characteristics of the Corporation Absence of Shareholder Rights to Be Involved in the Daily Running of the Corporation. Moreover: • The objectives of the corporation are determined by the board of directors; • The board of directors is elected / reelected by the shareholders, usually at the corporation’s Annual General Meeting; and, • The board of directors reports to shareholders regarding operations of / decisions made in relation to the company.
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2.1 Characteristics of the Corporation Limit to the Liability of Shareholders for Debts Incurred by the Corporation: Generally, shareholders will either have no liability or limited liability for the liabilities incurred by the corporation. The easiest way to understand the difference between these is by way of an example. 2.1 Characteristics of the Corporation Liability of Shareholders Example: Company ABC lists a new share issue on the market at a price of $3.00. The company decides to ask shareholders to initially pay $2.00 per share, with the remaining $1.00 to be paid at a later date.
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