Case Study
Instructions:
Please answer the following questions and show the steps of how you derived the final answer.
PACIFIC HEALTHCARE (B)
Stock Valuation
1. a. What is the estimated value of Pacific Healthcare stock on December 31, 2017?
b. Is the stock underpriced or overpriced?
c. If investors estimate that Pacific Healthcare will grow about 10 percent per year for the next five years (2018-2022), what constant growth rate (2023+) are they using to actually price the stock? (Hint: What constant growth rate (2023+) produces an actual December 31, 2017, stock price of $8?)
2. What is the estimated value on December 31, 2018, 2019, 2020, 2021, and 2022, assuming that the stock is in equilibrium?
3. Assume that the stock is in equilibrium and E(P0) = P0; that is, the current stock price equals the expected value that you calculated in Question 1a.
a. What are the estimated dividend yield, capital gains yield, and total return for 2018, 2019, 2020, 2021, and 2022?
b. Why do the estimated dividend yield and capital gains yield change every year?
c. What do you notice about the estimated total return?
d. What is the estimated dividend yield and capital gains yield after 2022? No additional calculations are required.
e. Why are investors interested in the relationship between dividend yield and capital gains yield?
4. At its next quarterly meeting, the Federal Reserve Board may increase the money supply, which could cause a fall in the risk-free rate and required rate of return on the market. On the other hand, a new administration may be in power after the next election, and this could cause an increase in investors' risk aversion and hence a higher risk-free rate and required rate of return on the market. Pacific Healthcare will soon sign several new lucrative contracts that could increase the expected constant growth rate, nonconstant growth rate, or current dividend (D0). Pacific Healthcare also has plans to stabilize revenues and profits in several of its large hospitals and this could cause the beta coefficient to decline. For these reasons, Marcia wants to know the sensitivity of the December 31, 2017, estimated value of Pacific Healthcare stock to changes in each model variable.
a. Graph the December 31, 2017, estimated value of Pacific Healthcare stock at +/- 10%, 20%, and 30% changes in each of the model variables (six lines on the graph, one for each variable).
b. To which variables is the estimated value most sensitive?