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Valuation of Securities and Cost of Capital

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These book values are unreliable because they might be significantly different from the current value of these assets. The values of assets and liabilities are based on past transactions that demonstrate no account of the future prospects.
A company’s assets can be evaluated on the basis of their market values. Market value of shares can be determined when they are traded on a recognised stock exchange. The share values estimated from the current market price are actual values, however this procedure becomes difficult when the company is unquoted. The market value of shares, which is also known as market capitalisation, is obtained by multiplying a company’s total shares in issue with the current market price per share. The current market price of Tesco plc is 384.50p per share and Sainsbury plc is 395.00p per share. Hence, the market capitalisation of Tesco and Sainsbury is 3,007m and 663m respectively (see appendix I).
P/E ratio is obtained when current market price per share is divided by earning per share. When the same ratio is inversed and earning per share is dividend by market price per share we get Earnings Yield. …
Earning per share is based on accounting profits and is derived form company’s financial statements. Tesco plc and Sainsbury plc’s EPS is 20.07p and 3.8p respectively. The P/E ratio for Tesco plc is 19.15 and Sainsbury plc is 103.94 (see appendix II), whereas the Earnings Yield of both these companies is 0.052 and 0.009 respectively (see appendix III). Although Sainsbury plc’s P/E ratio 103.94 is much higher than that of the Tesco plc i.e., 19.15, yet the earnings yield of Sainsbury plc is much lower than the Tesco plc. The reason is that Sainsbury’s EPS is considerably lower than the Tesco. Sainsbury plc is not more valuable than Tesco plc but shareholders perceive Sainsbury to be more valuable than Tesco, as reflected by the market prices of both the company’s shares.
Bonus shares are provided to shareholders without any cost as a form of dividend in lieu of cash dividends. The issue of bonus shares to the shareholders does not cause shareholders’ ownership to diminish, but it leads to the reduction of EPS and increase in P/E ratio. Tesco plc’s EPS before dilutive share options was 20.07p per share and after dilution it decreased to 19.79p per share (annual report 2006, p60). Sainsbury plc’s basic and diluted earnings are the same i.e., 3.8p per share because the company has closed all the share-options and share-plans (annual report 2006, p42). In the case of Right issues, companies issue shares at a price less than the one prevailing in the market also known as deep discounting. Such issues involve terms such as 1 for 4 etc. Right issues are used to raise long-term finances for a company for its investment decisions. This sort of share issuance also does not lead to a diminution in shareholder ownership, unless rights options are not