Week $5$: Stock Valuation

Question $1$

Chief Medical, Inc. is a little$-$known producer of heart pacemakers. The earnings and dividend growth prospects of the company are disputed by analysts.

Albert Bender at Goldman Sachs is forecasting $5\%$ growth in dividends indefinitely. However, Mary Montgomery at Morgan Stanley is predicting a $20\%$ growth in dividends, but only for the next three years, after which the growth rate is expected to be $4\%$ forever.

The Chief Medical annual dividend per share was $$3\mathrm{.}00$ for the most recent $12$ months and was paid recently. Stocks with similar risks currently are priced to provide a $14\%$ rate of return.

a$.$ What is the intrinsic value of a share of the stock according to Albert?

b$.$ What is the intrinsic value of a share of the stock according to Mary?

Question $2$

MusicTogether.com will pay out its first dividend, $$2\mathrm{.}00,$ one year from today. Analysts expect annual dividends to grow at a rate of $15\%$ per year for each of the following two years $($year $2$ through year $3)$ after which a normal growth of $6\%$ is expected indefinitely. Investors require a $12\%$ return from holding the stock of MusicTogether.com.

a$.$ What should be the current stock price of MusicTogether.com?

b$.$ If MusicTogether delays paying dividends for a year, i$.$e$.$ the first dividend will be paid out in two years from today. Accordingly, all later dividends are paid out one year later than originally projected. The pattern of growth rates stays the same, i$.$e$.,15\%$ for two years and $6\%$ thereafter. What is the stock price today?

Question $3$

Leona Motel$$s debt has a face value of $$40$ million, a coupon rate of $14\%($paid semiannually$),$ and expires in $12$ years $($at t $=12).$ The current annual yield$-$to$-$maturity $($stated$)$ for all bonds of the company is $15\%.$

Leona wishes to conserve cash for the next few years. To do this, Leona decides to issue new equity and use the proceeds to purchase the existing debt at the market price. The current stock price of Leona is $$60$ and there are $2$ million shares outstanding.

a$.$ How many shares should Leona issue to purchase the existing debt? Assume the decision to purchase the bond does not change the stock price.

Instead, the company decides to issue a zero$-$coupon bond that matures at year $5,$ and use the proceeds to purchase the existing debt at the market price.

b$.$ What is the face value of the zero$-$coupon bond that Leona needs to issue?