9-23 Stock Valuation Robert Balik and Carol Kiefer are senior Vice presidents of teh mutual of Chicago Insurance Company. They are codirectors of the company;s pension funds management division, with Balik having responsibility for fixed-income securities, (primarily bonds) and Keifer being responsible for equity investments. A major new client, the California League or citities, has requested that Mutual of Chicago present an investment seminar to the mayors of the represented citites; Balik and Leifer, 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 folloing questions.

a. Describe brifly the legal rights and privelies to common stockholders.

b.

1. Write a formula that can be used to value stock, regardless of the dividend pattern.

2. What is constant groth stock? How are constant groth stocks valued?

3. What are the implications if a company forecasts a constant g that exceeds its r _s? Will many stocks have expected g>r_s in the short run (i.e. for the next few years)? In the long run (i.e. forever)?

c. Assume that Bon Temps has a Beta coefficient of 1.2, that the risk-free rate (yeild on the T bonds) is 3%, and that the required rate of return on the market is 8%. What is Bon Temp's required rate of return?

d. Assume that Bon Temps is a constant growth company whose last dividend (D₀, which was paid yesterday) was $2.00 and whose dividendis expected to grow indefinitely at a 4% rate.

1. What is the firms expected fividend stream over the next 3 years?

2. What is the current stock price?

3. What is the stocks expected value 1 year from now?

4. What are the expected dividend yield, capital gains yeild, and total return during the first year?

e. Now assume that the stock is currently selling at $40.00. What is the expected rate of return?

f. What would the stock price be if its dividends were expected to have zero growth?

g. Now assume that Bon Temps dividend is expected to grow 30% the first year, 20% the second year, 10% the third year, and return to its long- run constant growth rate of 4%. What is teh stocks valueunder these conditions? What are its expected dividend and capital gains in year 1? year 4?

h. Supposee Bon Temps is expected to experiance zero growth during the first 3 years and the resume its steady-state growth of 4% in the fourth year. What would be its value then? What would its expected dividend and capital gains yeilds in year 1? year 4?

i. Finally assume that Bon Temp's earnings and dividends are expected to decline at a constant rate of 4% per year that is g+ 4%. 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 yeild each year?