Case scenario: Mutual of Chicago Insurance Company.
Stock Evaluation: 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, and employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads. You are to answer the following questions:
Q1. Describe briefly the legal rights and privileges of common stockholders.
Q2.
(1) Write a formula that can be used to value any stock, regardless of its dividend pattern.
(2) What is a constant growth stock? How are constant growth stocks valued?
(3) What are the implications if the company forecasts a constant g that exceeds its r? Will many stock have expected g > r in the short run (that is, the next few years)? In the long run (that is, forever)?
Q3. 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 Bonn Temps' required rate return?
Q4. Assume that Bon Temps is a constant growth company whose last dividend (Do, 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 ears?
(2) What is its current stock price?
(3) What is the stock expected value 1 years from now?
(4) What are the expected dividend yield, capital gain yield, and total return during the first year?
Q5. Now assume that the stock is currently selling at $30.29. What is its expected rate of return?
Q6. What would the stock price be if its dividends were expected to have zero growth?
Q7. Now assume the Bon Temps is expected to experience non-constant growth of 30% for the next 3 years, then return to is 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? And year 4?.