Chapter 9: Practice Problem-Stock Valuation STOCK VALUATION: 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 a. Assume that Bon Temps has a beta coefficient of 1.2, that the risk-free rate (the yield on T bonds) is 796, and that the return on the market is 12%, what is Bon Temps's required rate of return? b. 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 years? (2) What is its current stock price? (3) What is the stock's expected value 1 year from now? c. Now assume that Bon Temps is expected to experience non-constant growth of 30% for the next 3 years, and then return to its long-run constant growth rate of 6%, what is the stock's value under these conditions? d. 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 1096, and the projected free cash flows for the next 3 years are -$5 million, $10 million, and $20 million. After Year 3, free cash flow is projected to grow at a constant 696, what is the Total Value of Bon Temps? If it has 10 million shares of stock outstanding and $40 million of debt and preferred stock combined, what is the price per share? Chapter 9: Practice Problem-Stock Valuation STOCK VALUATION: 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 a. Assume that Bon Temps has a beta coefficient of 1.2, that the risk-free rate (the yield on T bonds) is 796, and that the return on the market is 12%, what is Bon Temps's required rate of return? b. 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 years? (2) What is its current stock price? (3) What is the stock's expected value 1 year from now? c. Now assume that Bon Temps is expected to experience non-constant growth of 30% for the next 3 years, and then return to its long-run constant growth rate of 6%, what is the stock's value under these conditions? d. 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 1096, and the projected free cash flows for the next 3 years are -$5 million, $10 million, and $20 million. After Year 3, free cash flow is projected to grow at a constant 696, what is the Total Value of Bon Temps? If it has 10 million shares of stock outstanding and $40 million of debt and preferred stock combined, what is the price per share