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Sam Strother and Shawna Tibbs are senior vice presidents of Mutual of Seattle. They are co- directors of the companys pension fund management division, with Strother having responsibility for fixed income securities (primarily bonds) and Tibbs responsible for equity investments. A major new client, the Northwestern Municipal Alliance, has requested that Mutual of Seattle present an investment seminar to the mayors of the represented cities, and Strother and Tibbs, who will make the actual presentation, have asked you to help them. To illustrate the common stock valuation process, Strother and Tibbs have asked you to analyze the Temp Force Company, an employment agency that sup-plies 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.
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 firms 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 firms expected dividend stream over the next 3 years?
(2) What is the firms current stock price?
(3) What is the stocks expected value 1 year from now?
(4) What are the expected dividend yield, the capital gains yield, and the total return during the first year?
e. Now assume that the stock is currently selling at $ 30.29. What is the expected rate of return on the stock?
f. What would the stock price be if its dividends were expected to have zero growth?
g. Now assume that Temp Force 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 stocks value under these conditions? What is its expected dividend yield and capital gains yield in Year 1? In Year 4?
h. Is the stock price based more on long- term or short- term expectations? Answer this by finding the percentage of Temp Forces current stock price based on dividends expected more than 3 years in the future.
i. Suppose Temp Force is expected to experience zero growth during the first 3 years and then to resume its steady- state growth of 6% in the fourth year. What is the stocks value now? What is its expected dividend yield and its capital gains yield in Year 1? In Year 4?
j. Finally, assume that Temp Forces earnings and dividends are expected to decline by a constant 6% per year, that is, g 6%. Why would anyone be willing to buy such a stock, and at what price should it sell? What would be the dividend yield and capital gains yield in each year?
k. What is market multiple analysis?
l. Temp Force recently issued preferred stock. It pays an annual dividend of $ 5, and the issue price was $ 50 per share. What is the expected return to an investor on this preferred stock?
m. Why do stock prices change? Suppose the expected D1 is $ 2, the growth rate is 5%, and rs is 10%. Using the constant growth model, what is the price? What is the impact on stock price if g is 4% or 6%? If rs is 9% or 11%?
n. What does market equilibrium mean?
o. If equilibrium does not exist, how will it be established?
p. What is the Efficient Markets Hypothesis, what are its three forms, and what are its implications?
The solution explains some questions relating to stock valuation