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HA2032 Corporate and finance Accounting Assignment
McPherson’s limited is the Australian based company, which is engaged in the products related with household goods, beauty, and personal care products. The company set up its operation in Australia, New Zealand and Asia (Annual report of McPherson, 2018). Further, the company finances its operations from the internal human resources such as retained earnings as well as from the external sources such as by issue of shares, debt and so on. Along with this company is improving its financial position by the investing in the product innovation techniques and the new market.
The investment decision of any investor is influenced by the value of the share of the company as well as the debt position of the company (Michaely, and Qian, 2017). MCP limited making many strategies for maintaining the optimal capital structure of the company, which leads to enhancing the growth of the company along with the growth of the shareholders of the company.
For evaluating the investment decision, equity valuation method is very good technique, by which an investor can get to know about the value of the share available for the owner or the shareholders of the company (Yu, Assad, and Fuller, 2016). There are various techniques of the equity valuation method, Gordon Growth method is one of the techniques, which assists the intrinsic value of the share based on the constant rate of the growth of the future dividend of the company. Gordon Growth Model assumes the company makes the payment of the dividend at the constant growth rate to the equity shareholders (Kung, and Schmid, 2015).
Valuation of the company
Gordon growth model
By applying the Gordon growth model technique the value of the share of McPherson’s limited can be estimated reliably since the dividend growth rate of the company is almost stable. Further, this technique does not affect by the market condition, which leads to an easy comparison between the companies of different size and different industries. Apart from this, it is a very common tool which can be applied by an investor for valuation of the shares so that they can take their decision regarding whether the investment in the company is beneficial to them or not. In this method, the Value of the share depends on the future dividend of the company, the rate of return of the company and the growth rate of the company (Jagannathan, and Liu, 2015).
Intrinsic Value = D1 / (k – g)
D1= expected annual dividend per share of the next year
K= expected the rate of return
G= expected dividend growth rate
In the case of McPherson’s limited
The intrinsic value of the McPherson’s limited by applying the above formula will be
= $ .935
However, the actual market price as on 30 June 2017 was $ 1.30
On the basis of the above calculation, it has been seen that the actual market price of the share of the McPherson’s limited was more than the intrinsic value of the share of the company, which leads that the share of the McPherson’s limited was overvalued. Therefore as an investor, it is not good to purchase the share of the company when it is overvalued. The goal of the investor is to buy the shares at the time when the price of the stock is lower and sell the share at the higher price. Therefore it is recommended that the investment in the McPherson’s limited will not be a good decision for the investor. However by analyzing the book value of the shares, price to book ration and many more aspect, an investor can make the more accurate decision for the capital investment purpose.
Since the Gordon Growth model is based only on the income from the dividend, it does not consider the other aspect of the income such as the capital gain, that can be earned by the investor from making the investment in the company. The basic assumption of this model is to the valuation of the shares of the company only through the return of the investment achieved by the shareholders by the dividend income. Further another assumption is that the growth rate of the dividend paid by the company is constant, however, in the practical situation, it may not be possible that the growth rate remains the same in the next year (Brightman, Masturzo, and Beck, 2015). Therefore the incorrect estimation may lead to the wrong overvaluation or undervaluation of the share price of the company, by which investor may not take proper decision. Overall it is a very traditional method of the valuation of the stock. There is another technique of valuation of the share of the company, which is better than the above method such as the comparable method, discounted cash flow models and so on; by applying these techniques investor may get the better decision.
1. Annual report of McPherson, 2018. Available through< https://www.mcphersons.com.au/sites/default/files/MCP%20Annual%20Report%20-%20Website.pdf>. [Accessed on 28th September 2018].
2. Brightman, C., Masturzo, J. and Beck, N., 2015. Are Stocks Overvalued? A Survey of Equity Valuation Models. Research Affiliates Fundamentals.
3. Jagannathan, R. and Liu, B., 2015. Dividend dynamics, learning, and expected stock index returns (No. w21557). National Bureau of Economic Research.
4. Kung, H. and Schmid, L., 2015. Innovation, growth, and asset prices. The Journal of Finance, 70(3), pp.1001-1037.
5. Michaely, R. and Qian, M., 2017. Stock liquidity and dividend policy: dividend policy changes following an exogenous liquidity shock. Routledge.
6. Yu, G., Assad, J.C. and Fuller, P., 2016. Using a Modified Dividend Discount Business Model for Stock Market Games. Sage.