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# Pam Alvarez and Shawna Jones are senior vice-presidents

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Question:Pam Alvarez and Shawna Jones are senior vice-presidents of Mutual of Whitewater. They are co-directors of the company’s pension fund management division, with Alvarez having responsibility for fixed income securities (primarily bonds) and Jones being responsible for equity investments. A major new client, the Southwestern Municipal Alliance, has request that Mutual of Whitewater present an investment seminar to the mayors of the represented cities, and Alvarez and Jones, who will make the actual presentation, have asked you to help them.

To illustrate the common stock valuation process, Alvarez and Jones have asked you to analyze the Temp Que Company, an employment agency that supplies word processor operators and computer programmers to businesses with temporarily heavy workloads. Stocks of companies with similar risk as Temp Que are currently yielding 13%. You are to answer the following questions (Show calculations clearly).

a. Describe briefly the legal rights and privileges of common stockholders (Refer to Section 7.2 in your textbook, pgs. 212-215).

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 constant g which exceeds its R? Will many stocks have expected g > R in the short run (i.e., for the next few years)? In the long run (i.e., forever)?

c. Assume that Temp Que 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 6 percent rate.

1) What is the firm’s expected dividend stream over the next 3 years?

2) What is the firm’s current stock price?

3) What is the stock’s expected value 1 year from now?

4) What are the expected dividend yield, the capital gains, and the total return?

d. What would the stock price be if its dividends were expected to have zero growth? (D0 = \$2.00)

e. Now assume that Temp Que is expected to experience supernormal growth of 30 percent for the next 3 years, then to return to its long-run constant growth rate of 6 percent. What is the stock’s value under these conditions? (D0 = \$2.00)

f. Is the stock price based more on long-term or short-term expectations? Answer this by finding the percentage of Temp Que’s current stock price based on dividends expected more than 3 years in the future, in the “supernormal growth” scenario in part (e) above.

g. Suppose Temp Que is expected to experience zero growth during the first 3 years and then to resume its steady-state growth of 6 percent in the fourth year. What is the stock’s current value now?

h. Why do stock prices change? Answer the question by using the following example: Suppose the expected D1 is \$2, the growth rate is 5 percent, and R is 10 percent.

1) Using the constant growth model, what is the price?

2) What is the impact on stock price if g is 4 percent or 6 percent, keeping R constant at 10 percent?

3) What is the impact on stock price if R is 9 percent or 11 percent, keeping g constant at 5 percent?

i. Based on all of the above, summarize the stock valuation process in your own words, in the form of a brief report. In your report you can refer back to any calculations that you have showed above. The report should be written clearly and legibly. Keep it organized as if it were a real business document and make sure that you have no grammar or spelling mistakes. Try to be concise. If you are proficient with typing equations and formulas in Word, you may type your report else hand-written reports (scanned or pictures) are also acceptable given that they are legible. A part of your grade will also be based on the overall writing and organization of the report. Write all group members’ names on the report.

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