Question

Robert Campbell and Carol Morris are senior vice-presidents of the Mutual ofChicago Insurance Company. They are co-directors of the company’s pension fund management division. A major new client has requested that Mutual of Chicago present an investment seminar to illustrate the stock valuation process. As a result, Campbell and Morris 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.

-Assume that Bon Temps is expected to experience supernormal growth of 30% for the next 3 years, then to return to its long-run constant growth rate of 6%. What is the stock’s value under these conditions? What are its expected dividend yield and its capital gains yield in Year 1? In Year 4?

-Suppose Bon Temps is expected to experience zero growth during the first three years and then to resume its steady-state growth of 6% in the fourth year. What is the stock’s value now? What are its expected dividend yield and its capital gains yield in Year 1? In Year 4?

Answer 1

Assuming all the amount of earning is being paid as dividend, expected dividend cannot be predicted as earnings value and payout ratio is not provided

Assumption 1: capital gain in Year 1 = 30%

Year 4 = 133%

Value at the end of year 4 will be 233% of its present value.

Assumption 2: Capital gain in year 1 will be 0%, whereas in year 4 will be 6%

Value at the end of year 4 will be 106% of its today value.