MM UGM ANGKATAN 46 KELAS

EKSEKUTIF A/KELAS B
Group 4 :
1.
2.
3..

STOCK AND
THEIR
VALUATION
 Problems
ROBERT BALIK AND CAROL KIEFER ARE SENIOR VICE PRESIDENTS OF THE MUTUAL OF CHICAGO
INSURANCE COMPANY. THEY ARE CO-DIRECTORS OF THE COMPANY'S PENSION FUND MANAGEMENT
DIVISION, WITH BALIK HAVING RESPONSIBILITY FOR FIXED INCOME SECURITIES (PRIMARILY BONDS)
AND KIEFER BEING RESPONSIBLE FOR EQUITY INVESTMENTS. A MAJOR NEW CLIENT, THE
CALIFORNIA LEAGUE OF CITIES, HAS REQUESTED THAT MUTUAL OF CHICAGO PRESENT AN
INVESTMENT SEMINAR TO THE MAYORS OF THE REPRESENTED CITIES, AND BALIK AND KIEFER, WHO
WILL MAKE THE ACTUAL PRESENTATION, HAVE ASKED YOU TO HELP THEM.

TO ILLUSTRATE THE COMMON STOCK VALUATION PROCESS, BALIK AND KIEFER HAVE ASKED YOU TO
ANALYZE THE BON TEMPS COMPANY, AN EMPLOYMENT AGENCY THAT SUPPLIES WORD PROCESSOR
OPERATORS AND COMPUTER PROGRAMMERS TO BUSINESSES WITH TEMPORARILY HEAVY
WORKLOADS. YOU ARE TO ANSWER THE FOLLOWING QUESTIONS.

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 Problems
Q-A : DESCRIBE BRIEFLY THE LEGAL RIGHTS AND PRIVILEGES OF COMMON STOCKHOLDERS.
Answer :
The common stockholders are the owners of a corporation, and as such they have certain rights and privileges as described below.

1. Ownership implies control. thus, a firm's common stockholders have the right to elect its firm's directors, who in turn elect the officers who
manage the business.
2. Common stockholders often have the right, called the preemptive right, to purchase any additional shares sold by the firm. in some states, the
preemptive right is automatically included in every corporate charter; in others, it is necessary to insert it specifically into the charter.

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 Problems
Q-B.1 : WRITE OUT A FORMULA THAT CAN BE USED TO VALUE ANY STOCK, REGARDLESS
OF ITS DIVIDEND PATTERN.
Answer :
The value of any stock is the present value of its expected dividend stream:

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 Problems
Q-B.2 : WHAT IS A CONSTANT GROWTH STOCK? HOW ARE CONSTANT GROWTH STOCKS VALUED?
Answer :
A constant growth stock is one whose dividends are expected to grow at a constant rate forever. "constant growth" means that the best estimate of
the future growth rate is some constant number, not that we really expect growth to be the same each and every year. many companies have
dividends which are expected to grow steadily into the foreseeable future, and such companies are valued as constant growth stocks.
FOR A CONSTANT GROWTH STOCK:
D1 = D0(1 + g), D2 = D1(1 + g)= D0(1 + g)2 … D∞ = D0(1 + g)∞.
 
WITH THIS REGULAR DIVIDEND PATTERN, THE GENERAL STOCK VALUATION MODEL CAN BE SIMPLIFIED TO THE FOLLOWING VERY IMPORTANT
EQUATION:

THIS IS THE WELL-KNOWN "GORDON," OR "CONSTANT‑GROWTH" MODEL FOR VALUING STOCKS. HERE D 1, IS THE NEXT EXPECTED DIVIDEND, WHICH
IS ASSUMED TO BE PAID 1 YEAR FROM NOW, k S IS THE REQUIRED RATE OF RETURN ON THE STOCK, AND g IS THE CONSTANT GROWTH RATE.

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 Problems
Q-B.3 : WHAT ARE THE IMPLICATIONS IF A COMPANY FORECASTS A CONSTANT g THAT EXCEEDS ITS r s ? WILL MANY STOCKS
HAVE EXPECTED g > rs IN THE SHORT RUN (i.e., FOR THE NEXT FEW YEARS)? IN THE LONG RUN (i.e., FOREVER)?
Answer :
rs = required, or minimum acceptable rate of return
g = expected growth rate in devidens as predicted

a. The model is derived mathematically, and the derivation requires that r s > g. If g is greater than rs , the model gives a negative
stock price which is nonsensical, wrong, meaningless, and misleading .

b. Stocks may have periods of supernormal growth, where g > rs , however, this growth rate cannot be sustained indefinitely.

c. In the long-run, g < rs

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 Problems
Q-C :ASSUME THAT BON TEMPS HAS A BETA COEFFICIENT OF 1.2, THAT THE RISK-FREE RATE (THE YIELD ON T-
BONDS) IS 7%, AND THAT THE REQUIRED RATE OF RETURN ON THE MARKET IS 12%. WHAT IS BOND TEMPS’S
REQUIRED RATE OF RETURN?
Answer :
β
1.2
1.2
STOCK RATE RETURN = 13%

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 Problems
Q-D : ASSUME THAT BON TEMPS IS A CONSTANT GROWTH COMPANY WHOSE LAST DIVIDEND (D0, 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
Answer :

growth=6% growth=6% growth=6% growth=6%

D0 = $2

D1= $2 (1+0.06)
= $ 2.12
D2= $2.12
(1+0.06)
= $ 2.247
D3= $2.247
(1+0.06)
= $ 2.38 D4= $2.38
(1+0.06)
= $ 2.52

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 Problems
Q-D : ASSUME THAT BON TEMPS 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.
2. WHAT IS ITS CURRENT STOCK PRICE
Answer :
P
P
P
P

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 Problems
Q-D : ASSUME THAT BON TEMPS IS A CONSTANT GROWTH COMPANY WHOSE LAST DIVIDEND (D0, WHICH WAS PAID YESTERDAY) WAS $2.00 AND WHOSE
DIVIDEND IS EXPECTED TO GROW INDEFINITELY AT A 6% RATE.
3. WHAT IS THE STOCK’S EXPECTED VALUE 1 YEAR FROM NOW?
Answer :

P
P
P
P

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 Problems
Q-D : ASSUME THAT BON TEMPS IS A CONSTANT GROWTH COMPANY WHOSE LAST DIVIDEND (D0, WHICH WAS PAID YESTERDAY) WAS $2.00 AND WHOSE
DIVIDEND IS EXPECTED TO GROW INDEFINITELY AT A 6% RATE.
4. WHAT ARE THE EXPECTED DIVIDEND YIELD, CAPITAL GAINS YIELD, AND TOTAL RETURN DURING THE FIRST OF RETURN?
Answer ;
E
P
P1 =
C
= 35.28 – 30.28 =
=
= 16.5%
Total Return = 7% + 16.5% = 23.5%

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 Problems
Q-E : NOW ASSUEME THAT THE STOCK IS CURRENTLY SELLING AT $30.29. WHAT IS ITS EXPECTED RATE OF
RETURN?
Answer :
r +g
r + 0.06
r13%

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 Problems
Q-F : WHAT WOULD THE STOCK PRICE BE IF ITS DIVIDENDS WERE EXPECTED TO HAVE ZERO GROWTH?
Answer :
P
P
P

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 Problems
Q-G :NOW ASSUME THAT BON TEMPS’S DIVIDEND IS EXPECTED TO GROW 30% FOR THE NEXT THREE YEARS,
AND RETURN TO ITS LONG-RUN CONSTANT GROWTH RATE OF 6%. WHAT IS THE STOCK’S VALUE UNDER
THESE CONDITIONS? WHAT ARE ITS EXPECTED DIVIDEND AND CAPITAL GAINS YIELDS IN YEAR 1? YEAR 4?
Answer :
BON TEMPS IS NO LONGER A CONSTANT GROWTH STOCK, SO THE CONSTANT GROWTH MODEL IS NOT
APPLICABLE. NOTE, HOWEVER, THAT THE STOCK IS EXPECTED TO BECOME A CONSTANT GROWTH
STOCK IN 3 YEARS. THUS, IT HAS A NONCONSTANT GROWTH PERIOD FOLLOWED BY CONSTANT
GROWTH. THE EASIEST WAY TO VALUE SUCH NONCONSTANT GROWTH STOCKS IS TO SET THE
SITUATION UP ON A TIME LINE AS SHOWN BELOW:

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 Problems
Q-G :
Answer :

= 2.3
 
 
 
= 2.6
=3
=

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 Problems
Q-G :
Year 1

Answer : = 49.18
P
P

Total Cash Flow = 66.65 +49.18= 70.96

Expected Devidend Yield = P1/P0 = 2.6/57.08 = 4/5%

Capital Gains Yield = P1 – P0/ P0 = 2.6 – 57.08/57.08 = -96.7%

Year 4
Capital gain yield = g = 6%
Expected devidend yield = rs – gs = 13% - 6% = 7%
 Problems
Q-H :SUPPOSE BON TEMPS IS EXPECTED TO EXPERIENCE ZERO GROWTH DURING THE FISRT 3 YEARS AND
THEN RESUME ITS STEADY-STATE GROWTH OF 6% IN THE FOURTH YEAR. WHAT WOULD BE ITS VALUE THEN?
WHAT WOULD BE ITS EXPECTED DIVIDEND AND CAPITAL GAINS YIELDS IN YEAR 1? IN YEAR 4?
Answer : growth=6%
growth=0% growth=0% growth=0%

D0 = $2 D2= $2 (1+0%) D4= $2 (1+0.06)

D1= $2 (1+0%) D3= $2(1+0%)
=$2 =$2 = $2 = $ 2.12

= 1.77      
= 1.56
= 1.39 =

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Q-H :
Answer : Problems
= 22.37
PO = Po + P1 + P2 + Pn
PO = $1.77 +$1.56 +$1.39 +$22.37
PO = $27.09
Year 1 – Zero Growth Stock
PO = D1/rs = 2/0.13 = $ 15.38/
Expected deviden yield = D1/PO = 2/15.38 = 13%
Capital Gain Yield = P1 – PO = 15.38 – 15.38 = 0
Year 4 – Constant Growth
Expected devidend yield = Rs – gs = 13% - 6% = 7%
Capital gain yield = g = 6%.
 Problems
Q-I : FINNALY, ASSUME THAT BON TEMP’S EARNINGS AND DIVIDENDS ARE EXPECTED TO DECLINE AT A
CONSTANT RATE OF 6% PER YEAR, THAT IS, g =-6%. WHY WOULD ANYONE BE WILLING TO BUY SUCH A
STOCK, AND AT WHAT PRICE SHOULD IT SELL? WHAT WOULD BE ITS DIVIDEND AND CAPITAL GAINS YIELDS IN
EACH YEAR?
Answer :
The company is earning something and paying some deviends. So it clearly has a value greather than zero. That
value can be found with the constant growth stock.
Capital gain yield = g = 6%
Hence = Devidend yield = 13% - (-6%) = 19%
The Devidend and capital gains yields are constant overtime, but a high (19) devidend yield & needed to offset
the negative capital gain yield.

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 Problems
Q-J :SUPPOSE BON TEMPS EMBARKED ON AN AGGRESSIVE EXPANSION THAT REQUIRES ADDITIONAL CAPITAL. MANAGEMENT DECIDED TO
FINANCE THE EXPANSION BY BORROWING $40 MILLION AND BY HALTING DIVIDEND PAYMENTS TO INCREASE RETAINED EARNINGS. ITS WACC IS
NOW 10%, AND THE PROJECTED FREE CASH FLOWS FOR THE NEXT THREE YEARS ARE -$5 MILLION, $10 MILLION, AND $20 MILLION. AFTER YEAR 3,
FREE CASH FLOW IS PROJECTED TO GROW AT A CONSTANT 6%. WHAT IS BON TEMPS’S TOTAL VALUE? IF IT HAS 10 MILLION SHARES OF STOCK AND
$40 MILLION OF DEBT AND PREFERRED STOCK COMBINED, WHAT IS THE PRICE PER SHARE?
Answer :

1 2 3  

=
D2= $20(1+0.06)
D0 = $-5 D1= $10 D2= $20
= $21.2

= -4.42
 
P2
 
= 7.83 P3
= 13.86

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 Problems
Q-J :
Answer :
Total Cash Flow = D1 + Pa = 310 + 20 = 330
Vop = 330 / ( 1+ wacc) = 330 / (1+0.1) = 300
Value Of Equity = Value Operation – DEBT
= 317.27 – 40
= $277.27
Price per share = $277.27/ 10
= $ 27.7

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 Problems
Q-K :SUPPOSE BON TEMPS DECIDED TO ISSUE PREFERRED STOCK THAT WOULD PAY AN ANNUAL DIVIDEND
OF $5.00 AND THAT THE ISSUE PRICE WAS $50.00 PER SHARE. WHAT WOULD BE THE STOCK’S EXPECTED
RETURN? WOULD THE EXPECTED RATE OF RETURN BE THE SAME IF THE PREFERRED WAS A PERPETUAL ISSUE
OR IF IT HAD A 20-YEAR MATURITY?
Answer :

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THANKS!
Any questions?

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