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Bond & Stock valuation - Case Study

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- 1. LOGOBond & Stock Valuation
- 2. Case SummaryThe dataPrevious year revenues: + $ 9 billionCapital structure: 34% Long Term Debt / 3% Preferred Stocks / 63 % Common StocksLong-Term Debt Preferred Stock Common StockLTD 1: c = 91/8 %, n = 26 years, =$ 930= 7 years, Premium = $ 104.4375LTD 2: c = 9%, n = 9 years, = $ 972.50Par Value = $1000D= $ 2.75 , Par Val = $30.50P = $ 30Voting rights: Only if company isarrears on 6 or more quarterlydividends = ¼ vote per shareIn case of liquidation: $ 30.50 +Accumulated dividendsn = 98 million sharesStock par value = $ 3.125P= $ 405/8Quarterly dividend = $ 0.385g = 9.7 %Max reinvestment = $ 1000 / month
- 3. 1. Look at the 91/8 percent coupon bond. What are itscurrent yield, its yield to-first call, and its yield-to-maturity?Remind: Current Yield is the annual income (interest or dividends) divided by the current price of thesecurity. This measure looks at the current price of a bond instead of its face value and represents thereturn an investor would expect if he or she purchased the bond and held it for a year.Other calculations forms: - Manual calculation of time value of money- Excel Sheet- Online Calculators
- 4. 1. Look at the 91/8 percent coupon bond. What are itscurrent yield, its yield to-first call, and its yield-to-maturity?Remind: Yield to first call is computed for a callable bond that is not currently callable. The actualcalculation is the same as the Yield to Maturity with the only difference being that instead of using a parvalue and the stated maturity the analyst will use the call price and the first call date in calculating the yield.Other calculations forms: - Manual calculation of time value of money- Excel Sheet- Online Calculator
- 5. 1. Look at the 91/8 percent coupon bond. What are itscurrent yield, its yield to-first call, and its yield-to-maturity?Remind: Yield to maturity is the rate that will make the present value of a bonds cash flows equal to itsmarket price plus accrued interest.Other calculations forms: - Manual calculation of time value of money- Excel Sheet- Online Calculator
- 6. 2. Do you think this bond will be called? Why or why not?
- 7. 3.What would be the value of the 91/8 percent coupon bond if the time to maturitywas 10 years rather than 26 years? Can you explain why your answer is correct?The coupon rate (coupon yield = nominal yield) is simply the coupon payment (C)as a percentage of the face value (F): c= C / Par Value.
- 8. 4. What is the required rate of return for the preferred stock? How does this ratecompare to the YTM for the HPI 91/8 percent bond? Is this difference what youwould have expected from a risk / return standpoint? Why or why not?The required rate of return for preferred stock is higher than YTM for the HPI 9 bond. The reason is relatedwith the degree of risk. As we know, preferred stocks are riskier than bonds.
- 9. 5. In the event of liquidation, HPI preferred stockholders areentitled to $ 30.50 plus accrued dividends. Does this meanthat preferred stockholders will receive that amount?The preferred stocks arecumulative which means that the firmcannot pay the common stocks untilit has paid all its obligations withaccumulated dividends during theprevious periods. One thing it’s sure:they will paid before commonshareholders but this does not meanthat they will be paid for the entireamount. They will receive as muchas possible from the liquidation.
- 10. 6.What are the dividend yield and the expectedcapital gains yield for HPI common stock?Remind : Dividend yield is a financial ratio that shows how much a company pays out in dividends eachyear relative to its share price. In the absence of any capital gains, the dividend yield is the return oninvestment for a stock.
- 11. 6. What are the dividend yield and the expectedcapital gains yield for HPI common stock?Remind : Capital gain yield is the price appreciation component of a securitys (such as a commonstock) total return. For stock holdings, the capital gains yield will be the change in price divided by theoriginal (purchase) price.
- 12. 7. Given that HPI is selling for $ 405/8 what is its required rateof return?Remind: Constant growth model (Gordon Model Growth) is a model for determining the intrinsic valueof a stock, based on a future series of dividends that grow at a constant rate. Given a dividend per sharethat is payable in one year, and the assumption that the dividend grows at a constant rate inperpetuity, the model solves for the present value of the infinite series of future dividends (Investopedia).
- 13. 8. Assume that the risk-free rate is 7 percent and that the expected return of themarket is 12 percent. According to the security market line valuation model,what is the required rate of return for HPI common stock if its beta is 1.10?Remind: The security market line (SML)is theline that reflects an investments risk versus itsreturn, or the return on a given investment inrelation to risk. The measure of risk used for thesecurity market line is beta. The line begins withthe risk-free rate (with zero risk) and movesupward and to the right. As the risk of aninvestment increases, it is expected that the returnon an investment would increase. An investor witha low risk profile would choose an investment atthe beginning of the security market line. Aninvestor with a higher risk profile would thuschoose an investment higher along the securitymarket line.
- 14. 9. Using the constant growth valuation model, find the presentvalue of HPI common stock. Would you buy or sell?This common stock has a sale price $ 405/8 which is lower that the stock present value. As we can see, thestock is under valuated and in this case a “smart strategy” will be to buy the stocks with a lower price.
- 15. 10. The constant growth model is used in textbooks as a conceptual model to explainchanges in stock prices. Is the model also of value for the actual valuation of stocks?g = constantBook theory!VariablegrowthDynamicenvironmentVariable g:Moreaccurate modelThree step modelVariable g:Difficulties incalculation
- 16. LOGO

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