Case #72

Swan-Davis Corporation - Stock & Bond Valuation

Summary of Case

Question 1

If an investor bought some of SDI's A bonds at the current market price, what would be his or her yield to maturity?

Response:

Question 2

Like many other bonds, SDI's A bonds have a call provision.What is the yield to call on this issue?Which return would an investor be more likely to receive on this bond if it were purchased today, the YTM or the YTC?

Response:

Question 5

Explain the difference between interest rate risk and reinvestment rate risk. Which of the above bonds, A or B, has more interest rate risk? Which has more reinvestment rate risk?

Response:

Question 7

What effect do factors such as the ROE, the debt ratio, analysts' earnings growth rate forecasts, business risk, projected income statements, and industry average data have on the stock valuation process?

Response:

Question 8

Develop a reasonable estimate or range of estimates for SDI's cost of equity capital using the CAPM method. Tony Biddle informed you that 20-year Treasury bonds currently yield 6.1 percent, while the yield on 90-day T-bills is 5.2 percent.

Response:

Question 10

a. What is SDI's required rate of return (ks) using nonconstant DCF methodology?Assume the following conditions: SDI's current stock price is $15; investors expect a dividend cut to $0.20 in 1997, after which the company will experience a supernatural dividend growth rate of 20 percent per year out to 2001 and a normal growth rate of 14.9 percent in 2002 and thereafter.

Response:

b.Assuming the forecast in Table 5 is correct, show how the projected 1997 year-end stock price of $17.30 and the projected 2001 year-end stock price of $30.20 were calculated.

Response:

c.Through sensitivity analysis show what the stock price would be with the cost of equity capital (rs) at= 17 percent, by making changes in the grow rate of dividends during the first and second growth periods.Complete the table below:

First Period Growth

5%

12%

15%

20%

23%

2^nd Period Growth

3.0%

10.0%

14.9%

16.0%

16.5%

Hint:To complete the above table, use an Excel spread sheet model to calculate the basic g₁ = 20% and g₂ = 14.9% value.Then using the data>table function (use help if you are not familiar with it) construct a two variable data table to effectively calculate sensitivity analysis on the two growth rates.

Response: