Question

Your employer, a mid-sized human resources management company, is considering
expansion into related fields, including the acquisition of Temp Force Company, an
employment agency that supplies word processor operators and computer programmers
to businesses with temporary heavy workloads. Your employer is also considering the
purchase of a Biggerstaff & Biggerstaff (B&B), a privately held company owned by two
brothers, each with 5 million shares of stock. B&B currently has free cash flow of $24
million, which is expected to grow at a constant rate of 5%. B&B’s financial statements
report 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 dividend
pattern.
(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 stocks
have 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 yield
on T-bonds) is 7.0%, and that the market risk premium is 5%. What is the required
rate 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 grow
indefinitely 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 the
expected total return during the first year?

Answer 1

a)Legal rights and priviledges of common stock holders are:

• they have right to vote in general meetings
• right to receive dividend in case of profits (however its not necessary that they will receive the dividend everytime the company earns profit)
• they are considered owners of company
• they have right to elect board of directors of the company
• they enjoy preemptive right to buy new shares of the company before they are offered to the public

b)

1.the formula for valuing common stock,regardless of dividend pattern is:

value of share=constant dividend per share/required rate of return of investors

so,value of a share is equal to the present value of all future dividends it is expected to provide over an infinite period.

2)The stock in which dividends are assumed to grow at a constant rate which is less than the required rate of investor.

They are valued by using constant growth model,primarily known as gordon model.

value of stock =expected dividend/required return of investor-growth rate in dividend

3)rs???

c)Required rate of return on firm asset=risk free rate of return+betacoefficient*(market risk premium)

=7%+1.2*(5%)=13%

d)

1)firm current estimated intrinsic stock price=D0/required rate of return-dividend growth rate

required rate of return would be 12% because risk free rate of return+market risk premium =12% i.e. 7%+5%

=$2.00/12%-6%=2/0.12-0.06=$33.34

2)stock expected value one year from now would be=$2.12/0.12-0.06=$35.34

expected dividend =$2(1+0.06)=$2.12

3)expected dividend yield=$2.12-$2.00/$2.00=0.06=6%

expected capital gains yield=$35.34-$33.34/$33.34=5.99%

expected total return during the first year=$0.12+$2/$33.34=6.36%