Managerial Finance
MINI CASE 1:
Your employer, a mid-sized human resources management company, is consideringexpansion into related fields, including the acquisition of Temp Force Company, anemployment agency that supplies word processor operators and computer programmersto businesses with temporary heavy workloads. Your employer is also considering thepurchase of a Biggerstaff & Biggerstaff (B&B), a privately held company owned by twobrothers, each with 5 million shares of stock. B&B currently has free cash flow of $24million, which is expected to grow at a constant rate of 5%. B&B's financial statementsreport marketable securities of $100 million, debt of $200 million, and preferred stock of$50 million. B&B's WACC is 11%. Answer the following questions.
a. Describe briefly the legal rights and privileges of common stockholders.
b. (1) Write out a formula that can be used to value any stock, regardless of its dividendpattern.
(2) What is a constant growth stock? How are constant growth stocks valued?
(3) What happens if a company has a constant g that exceeds its rs? Will many stockshave expected g >rs in the short run (i.e., for the next few years)? In the long run(i.e., forever)?
c. Assume that Temp Force has a beta coefficient of 1.2, that the risk-free rate (the yieldon T-bonds) is 7.0%, and that the market risk premium is 5%. What is the requiredrate of return on the firm's stock?
d. Assume that Temp Force is a constant growth company whose last dividend (D0,which was paid yesterday) was $2.00 and whose dividend is expected to growindefinitely at a 6% rate.
(1) What is the firm's current estimated intrinsic stock price?
(2) What is the stock's expected value 1 year from now?
(3) What are the expected dividend yield, the expected capital gains yield, and theexpected total return during the first year?
MINI CASE 2
Sam Strother and Shawna Tibbs are vice presidents of Mutual of Seattle InsuranceCompany and co-directors of the company's pension fund management division. Animportant new client, the North-Western Municipal Alliance, has requested that Mutualof Seattle present an investment seminar to the mayors of the represented cities, andStrother and Tibbs, who will make the actual presentation, have asked you to help themby answering the following questions.
a. What are the key features of a bond?
b. What are call provisions and sinking fund provisions? Do these provisions makebonds more or less risky?
c. How does one determine the value of any asset whose value is based on expectedfuture cash flows?
d. How is the value of a bond determined? What is the value of a 10-year, $1,000 parvalue bond with a 10% annual coupon if its required rate of return is 10%?
e. (1) What would be the value of the bond described in part d if, just after it had beenissued, the expected inflation rate rose by 3 percentage points, causing investorsto require a 13% return? Would we now have a discount or a premium bond?
(2) What would happen to the bond's value if inflation fell and rd declined to 7%?Would we now have a premium or a discount bond?
(3) What would happen to the value of the 10-year bond over time if the requiredrate of return remained at 13%? If it remained at 7%?
(Hint: With a financialcalculator, enter PMT, I/YR, FV, and N, and then change N to see what happensto the PV as the bond approaches maturity.)
f. (1) What is the yield to maturity on a 10-year, 9% annual coupon, $1,000 par valuebond that sells for $887.00? That sells for $1,134.20? What does the fact that abond sells at a discount or at a premium tell you about the relationship betweenrd and the bond's coupon rate?