Sam Strother and Shawna Tibbs are senior
vice presidents of Mutual of Seattle. They are co-directors of the company’s
pension fund management division, with Strother having responsibilities for
fixed income securities (primarily bonds) and Tibbs responsible for equity
investments. A major new client, the Northwestern Municipal Alliance, has
requested that Mutual of Seattle present and investment seminar to the mayors
of the cities in the association, and Strother and Tibbs, who will make the actual
presentation, have asked you to help them.
To illustrate the common stock valuation
process, Stother and Tibbs have asked you to analyze the Temp Force Company, an
employment agency that supplies word processor operators and computer
programmers to business with temporarily heavy workloads. You are to answer the
following questions.
a.(1) Write out a formula that can be used to
value any stock, regardless of its dividend pattern.
(2)
What happens if a company has a constant g that exceeds its r
s?
Will
many stocks have expected g> r
s in the short run ( i.e. for the next few
years)? In the long run (i.e., forever)?
b.Assume
that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the
yield on T-bonds) is 7.0%, and that the market risk premium is 5%. What is the
required rate of return on the firm’s stock?
c.Assume that Temp Force is a constant growth
company whose last
dividend (D
0, which
was paid yesterday) was $2.00 and whose dividend
is expected to grow indefinitely at a 6% rate.
1.What
is the firm’s expected dividend stream over the next 3 years?
2.What
is the firm’s current intrinsic stock price?
3.What
is the stock’s expected value 1 year from now?
4.What are the expected dividend yield, the
expected capital gains yield, and the expected total return during the first
year?
d.Now
assume that the stock is currently selling at $30.29. What is the expected rate
of return?
e.What
would the stock price be if the dividends were expected to have zero growth?
f.Now
assume that Temp Force’s dividend is expected to experience supernormal growth
of 30% from Year 0 to Year 1, 20% from Year 1 to Year 2, and 10% and Year 2 to
Year 3. After Year 3, dividends will grow at a constant rate of 6%. What is the
stock’s intrinsic value under these conditions? What are the expected dividend
yield and capital gains yield during the first year? What are the expected
dividend yield and capital gains yield during the fourth year ( from Year 3 to
Year 4)?
g.Is
the stock price based more on long-term or short-term expectations? Answer this
by finding the percentage of Temp Force’s current stock price that is based on
dividends expected more than 3 years in the future.
h.Suppose
Temp Force is expected to experience zero growth during the first 3 years and the
to resume its steady-state growth of 6% in the fourth year. What is the stock’s
intrinsic value now? What is its expected dividend yield and its capital gains
yield in Year 1? In Year 4?
i.Now
suppose that Temp Force’s earnings and dividends are expected to decline by a
constant 6% per year forever-that is, g= -6%. Why would aanyone be willing to
buy such a stock, and at what price should it sell? What would be the dividend yield and capital
gains yield in each year?
j.What is market multiple analysis?
k.Temp
Force recently issued preferred stock that pays an annual dividend of $5 at a
price of $50 per share. What is the expected return to an investor who buys
this preferred stock?
m.Why
do stock prices change? Suppose the expected D1 is $2, the growth rate is 5%,
and r
s is10%. Using the constant growth model, what is the stock’s price?
What is the impact on the stock price if g falls to 4% or rises to 6%? If r
s
increases to 9% or to 11%?