Case stock and bond valuation


Case stock and bond valuation

Dynamic Health Laboratories, Inc. is a leading manufacturer of various health products – specialty foods candies and proprietary drugs. Important product names include a wide range of Noni products – dietary supplement soft gels, Citrifolia High Potency Noni Juice, Women’s’ Choice Formula Noni, Dynamic Health Choice Vitality Formula Noni Juice (what a name!) and a host of other products competing for the fanciest names. Total revenue in 2013 were in excess of $9 billion.

Long-Term Debt

The company has a capital structure that is made up of 34 percent long-term debt, 3 percent preferred stock and 63 percent common stock. One of the two largest domestic long-term debt issues is a 91/8 percent coupon bond that is due in 26 years. This debenture is currently selling for $930. The bond is callable in seven years and if called, will be redeemed a premium of 104.4375. The other large publicly-held bond is a 9 percent coupon bond that is due in nine years. This debenture is selling for $972.50. Both of these bonds are rated A by Standard and Poor’s and Moody’s.

Preferred Stock

The preferred stock is $2.75 cumulative preferred with a stated value of $30.50, but it is currently, but is currently selling for $30. More than 5.5 million shares were issued recently with the merger of CPI Holding Company into a subsidiary of DHL. The preferred stock has no voting rights unless the company is in arrears on six or more quarterly dividends, and then each shareholder is entitled to one-quarter vote per share. In the event of liquidation each share is entitled to $30.50 plus accrued dividend.

Common Stock

Returns from common stock come from the cash dividend payment and/or changes in the price of the stock. Investors receiving dividends can expect them to grow over time, but some stocks do not pay dividends, especially during their early growth years. As firms mature, they typically start paying dividends and then management is very reluctant to reduce the dividend. For firms that do pay dividends, the normal assumption is that the earnings are being retained by the firm to promote growth; thus, the stock price should grow at a higher rate than firms that have high payout ratios.

Two major factors that affect the price of stock are changes in the required rate of return, caused primarily by changes in risk, and change in growth rate of earnings, which in turn create changes in the growth rate of dividends.

The common stock of Dynamic Health currently has over 95 million shares of $3.125 par value stock outstanding. A share of common stock presently sells for $405/8 and pays quarterly dividends of $0.385. A consensus estimate (Zack’s and IBES) indicates that earnings and dividends are expected to grow at an annual rate of 9.7 percent for the next five years. The common shares have no preemptive rights. Stockholders of DHL have the opportunity to buy additional shares of common through a plan of automatic dividend reinvestment and optional cash purchase. This plan allows stockholders to have their dividends reinvested in shares of common stock, and they can purchase additional shares at the market price (with no commission) each month. Shareholders who participate in this plan are limited to a total of $1,000 per month that they can use to purchase additional shares.

QUESTIONS

1. Look at the 91/8 percent coupon. What is its current yield, its yield-to-first call, and its yield-tomaturity?

2. Do you think this bond will be called? Why or why not?

3. What would be the value of 91/8 percent coupon bond if the time to maturity was 10 years rather than 26 years? Explain why your answer is correct.

4. What is the required rate of return for the preferred stock? How does the rate compare to the yield to maturity for the DHL 91/8 percent bond? Is this difference what you have expected from a risk/return standpoint? Why or why not?

5. In the event of liquidation, DHL preferred stockholders are entitled to $30.50 plus accrued

dividends. Does this mean that preferred stockholders will receive that amount?

6. What is the dividend yield and the expected capital gains yield for DHL common stock?

7. Given that DHL is selling for $40 5/8, what is its required rate of return? [use the constant growth valuation model]

8. Assume that the risk-free rate is 7 percent and the expected return of the market is 12 percent. According to the security market line, valuation model, what is the required rate of return for DHL common stock if its beta coefficient is 1.10?

9. Using the constant growth valuation model, find the present value of DHL common stock. Would you buy or sell this stock?

10. The constant growth model is used in textbooks as a conceptual model to explain changes in the in stock price. Is the model also of value for the actual valuation of stock?

11. Calculate the duration of the 26 year bond 

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Finance Basics: Case stock and bond valuation
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