Question

Their new task consisted of determining Entergy Corp.’s value in common stock, preferred stock, and bonds. With this information, they were to prepare a second seminar to explain the valuation process to the clients

Nicholas and Karina were able to obtain the following information in regard to Entergy Corp.’s long term obligations. The table indicates the first three first-mortgage bonds listed in the Annual Report.

Table 1

Face Amount	$48,000	$32,000	$100,000
Coupon Rate	4.5%	8.5%	12.62%
Maturity Year	1997	2007	2017
Years to Maturity	5	15	25

Nicholas and Karina concluded that the effect of increased concern in regards to any event risk, was to lower Entergy Corp.’s cost of bond financing. The following information was gathered through the use of Value Line Survey.

Entergy’s recent price was $38 per share with a P/E of 14.6 and a dividend yield of 4.8%. Its beta was .60.

Year	ROE	Pay-Out-Ratio
2000	15.3%	67%
2001	16.8%	66%
2002	16.0%	67%
2003	15%	69%
2004	15%	70%
Estimated 05-07	16%	67%

Earnings Per Share

Year	March 31	June 31	Sept. 31	Dec. 31	Full year	Est. 05-07
2000	.49	.62	.80	.45	2.36
2001	.48	.68	.80	.49	2.45
2002	.46	.67	.86	.56	2.55
2003	.47	.68	.90	.55	2.60
2004	.50	.72	.95	.58	2.75	3.30

Quarterly Dividends Paid Per Share

Year	March 31	June 30	Sept. 30	Dec. 31	Full year	Est. 05-07
2000	.335	.355	.355	.355	1.40
2001	.355	.38	.38	.38	1.50
2002	.38	.405	.405	.405	1.60
2003	.405	.43	.43	.43	1.70
2004	.43				1.90	2.25

Annual Rates	Past 10 yrs.	Past 5 yrs.	Estimated 99-01 to 05-07
Revenue	1.5%	5.5%	5%
Cash Flows	6.5%	8%	4%
Earnings	6%	6.5%	5%
Dividends	7.5%	6.5%	6%
Book Value	4.5%	3.5%	5.5%
ROE			16.2%

FMS SECURITIES CASE B - Questions

1.) Entergy Corp. has $54,956,000 of preferred stock outstanding.

a.) Suppose its Series A, which has a $100 par value and pays a 4.32 percent cumulative dividend, currently sells for $48.00 per share. What is its nominal expected rate of return? It’s effective annual rate of return? (Hint: Remember that dividends are paid quarterly. Also, assume that this issue is perpetual.)

b.) Suppose a Series F, with a $100 par value and a 9.75 percent cumulative dividend, has a mandatory sinking fund provision. 60,000 of the 300,000 total shares outstanding must be redeemed annually at par beginning at the end of 2004. If the nominal required rate of return is 8.0 percent, what is the current (January 1, 2004) value per share?

2.) Now consider Entergy Corp.’s common stock. Value Line estimates Entergy Corp.’s 5- year dividend growth rate to be 6.0 percent. Assume that Entergy Corp.’s stock traded on January 1, 2003 for $22.26. Assume for now that the 6.0 percent growth rate is expected to continue indefinitely.

a.) What was Entergy Corp.’s expected rate of return at the beginning of 2003? Value Line estimate Entergy Corp.’s dividends to be $1.80 at the start of 2003.

b.) What was the expected dividend yield and expected capital gains yield on January 1,

2003? Describe the relationship between dividend yield and capital gains yield over time under constant growth assumptions.

3.) What conditions must hold to use the constant growth (Gordon) model? Do many “real world” stocks satisfy the constant growth assumptions?

4.) Suppose you believe that Entergy Corp.’s 6.0 percent dividend growth rate will only hold

5 years. After that, the dividend growth rate will return to Entergy Corp.’s historical 10-year

average of 7.5 percent. Note that D6 = D5 x 1.075. (Use to answer questions 4-8)

a.) What was the value of Entergy Corp.’s stock on January 1, 2003 (the end of 2002), if the required rate of return is 13.5 percent? Remember this value you calculate does

not have to agree with the market value of $22.26.

5.)

a.) What is the expected stock price at the end of 2003 (beginning of 2004) assuming

that the stock is in equilibrium?

b.) What is the expected stock price at the end of 2004 (beginning of 2005) assuming

that the stock is in equilibrium?

6.) What is the expected dividend yield, capital gains yield, and total return for 2003?

Hint: You need the expected January 1, 2003 price to compute.

7.) Suppose Entergy Corp.’s dividend was expected to remain constant at $1.80 for the next 5 years and then grow at a constant 6 percent rate. If the required rate of return is 13.5 percent, would Entergy Corp.’s stock value be higher or lower than your answer in Problem 4?

8.) Entergy Corp.’s stock price was $22.26 at the beginning of 2003. Using the growth rates given in the introduction to this question, what is the stock’s expected rate of

return?

9.) Based on the information provided in Value-Line Tables is the assumed 6 % growth rate reasonable? What has been the trend?

10.) Given Value-Line’s ROE estimated for 2005 through 2007 and at the projected

earnings and dividends per share for the same period.

1. Could those figures be used to develop an estimated long-run “sustainable” growth rate?

2. Does this figure support the 7.5 percent growth rate given in the problem?

Hint: Think of the formula g = br = (Retention ratio)(ROE)

Answer 1