CASE STUDY IN

STOCK
VALUATION
GROUP 7
 Robert Balik and Carol Kiefer are senior vice presidents of the Mutual
of Chicago Insurance Company. They are codirectors of the company’s
pension fund management division, with Balik having responsibility for
fixed-income securities (primarily bonds) and Kiefer being responsible
for equity investments. A major new client, the California League of
Cities, has requested that Mutual of Chicago present an investment
seminar to the mayors of the represented cities, and Balik and Kiefer,
who will make the actual presentation, have asked you to help them.
To illustrate the common stock valuation process, Balik and Kiefer
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.
A. Describe briefly the legal rights and privileges of common
stockholders.

RIGHT TO CONTROL OVER MANAGEMENT

RIGHT TO VOTE (VOTING RIGHTS)
RIGHT TO SHARE IN PROFITABILITY
RIGHT TO BUY ADDITIONAL SHARES (PREEMPTIVE RIGHTS)
B. Assume that Bon Temps has a beta coefficient of 1.2, that
the risk-free rate (the yield on T-bonds) is 7%, and that
the required rate of return on the market is 12%. What is
Bon Temps’ required rate of return?

𝒓𝒔 = 𝑹𝒇 + 𝒃𝒋 × 𝒓𝒎 − 𝑹𝒇
𝒓𝒔 = 𝟕% + 𝟏. 𝟐 × 𝟏𝟐% − 𝟕%
𝒓𝒔 = 𝟏𝟑%
C. Assume that Bon Temps is a constant growth company whose dividend was
₱2.00 and whose dividend to grow indefinitely at 6% rate.
1. What is the firms expected dividend stream to the next 3 years?
D₁= D₀ x (1+g)
=₱2.00 x (1+.06) = P2.12
D₂= D₀ x (1+g) ²
=₱2.00 x (1+.06) ² = P2.247
D₃= D₀ x (1+g) ³
= ₱2.00 x (1+.06)³ = P2.382
2. What is the current stock price?

P₀= 𝐷₁
𝑟𝑠−𝑔
𝑃2.12
=
.13−.06

= ₱30.29
 3. What is the stocks expected value 1 year from now?

𝐷₂
P₁=
𝑟𝑠−𝑔

2.247
=
.13− .06
= ₱32.10

D. What would the stock price if its dividend were expected to have zero
growth?
𝐷 𝑃2.00
P₀= = = ₱15.38
𝑟𝑠 .13
E. Assuming that the firms experience a slowing dividend growth of 2%
annually. What would be the value of stock under variable-growth
model?
1st step, find the value of cash dividends at the end of each year
D₁= ₱2.12, D₂= ₱2.247, D₃= ₱2.382

2nd step, find the present value of the dividends expected during the
initial growth period
PRESENT VALUE
T
D𝑡 (1+rs)ᵗ 𝐃𝐭
(years)
(𝟏 + 𝐫𝐬)ᵗ
1 ₱ 2.12 1.13 1.876
2 ₱2.247 1.277 1.76
3 ₱2.382 1.443 1.650

𝐷₀×(1+𝑔)ᵗ
σ3𝑡=1 = ₱5.286
(1+𝑟𝑠)𝑡
3rd step, find the value of stock at the end of initial growth period

*1st the value of stock at the end of the initial growth period (N = 3) can be
found by first calculating D𝘯+1= D₃₊₁= D₄

D₄= D₃ x (1+g)
= ₱2.382 x (1+.02)
=₱2.43

*2nd by using D₄= ₱ 2.43, a 13% required return, and a 2% dividend growth
rate, the value of stock at the end of 3rd period is calculated as follows;

𝐷₄
P₃=
𝑟𝑠−𝑔2
2.43
=
.13−.02

= ₱ 22.09
*3rd the share value of ₱ 22.09 at the end of 3rd period must be converted into a
present value. Using the 13% required return, we get

𝑃₃ 22.09
= = ₱ 15.31
(1+𝑟𝑠)³ (1+.13)³

4th step, add the present value components found in step 2 and 3 to
find the value of stock, P₀

P₀= ₱ 5.286 + ₱ 15.31

= ₱ 20.6
F. Assuming that the firm weighted average cost of capital is 9% and it has ₱500 000 of
debt at a market value and ₱200 000 of preferred stock at its assumed market value.
The estimated Free Cash flow over the next 5 years is given below. Beyond 5 years to
infinity, the firm expects its free cash flow to grow by 5% annually. The firm has 50
000 shares of common stock outstanding.

YEAR FREE CASH FLOW

1 ₱ 50 000
2 90 000
3 110 000
4 200 000
5 250 000
Step 1; calculate the present value of the free cash flow occurring at the
end of 6th period to infinity
𝐹𝐶𝐹₆
Value of FCF₆=
𝑟ₐ−𝑔
250 000(1+.05)
=
.09−.05

= ₱ 6 562 500
Step 2; add the present value of the FCF from 6th period to infinity, which
is measured at the end of 2017

Total FCF₅= ₱ 250 000 + 6 562 500

= ₱ 6 812 500
Step 3; find the sum of the present values of the FCFs for 1st to 5th
period to determine the value of entire company, Vc. This calculation is
shown in a table;

Year Present Value of FCF

FCF (1+rₐ)ᵗ 𝑭𝑪𝑭
(t) (𝟏 + 𝐫ₐ)ᵗ

1 50 000 1.09 45 872

2 90 000 1.188 75 758
3 110 000 1.3 84 615
4 200 000 1.41 141 844
5 6 812 500 1.54 4 423 701
Value of
entire
company,
4 771 790
Vc
Step 4; Calculate the value of common stock

Vs= Vc-VD-Vp
=4 771 790 – 500 000 – 200 000
= 4 071 790

By dividing the 50,000 outstanding share

4 071 790
=
50 000 𝑠ℎ𝑎𝑟𝑒𝑠

= 81.44 per share

G. Assume that the firm has a required return of 13%. The company, which plans to
pay a dividend of ₱ 2.60 per share in the coming year, anticipates that its future
dividends will increase at annual rate consistent with that experienced over
2009-2015 period, when the following dividends were paid:

Year Dividend Per Share

2015 ₱ 2.45
2014 2.28
2013 2.10
2012 1.95
2011 1.82
2010 1.80
2009 1.72

1. If the risk-free rate is 10%, what is the risk premium of the firm?

𝒓𝒔 = 𝑹𝒇 + 𝑹𝑷
13%= 𝟏𝟎% + 𝑹𝑷
𝑹𝑷= 13%-10%
𝑹𝑷 = 3%
2. Using the constant-growth model, estimate the value of the firm?
GIVEN: 𝑛=6 𝐹𝑉 = ₱ 2.45 𝑃𝑉 = ₱ 1.72
1
𝐹𝑉𝑛 𝑛
𝐷1 𝑔= −1
𝑃𝑉
𝑃𝑜 = 1
𝑟𝑠 − 𝑔 2.45 6
𝑔= −1
2.60 1.72
𝑃𝑜 = 𝑔 = 6.07%
13% − 6.07%

𝑷𝒐 = 𝟑𝟕. 𝟓𝟐

3. Explain what effect, if any, a decrease in the risk premium would have on the
value of the firm.

BACK TO TOP