Valuation FMS Securities (B) Nicholas and Karina, the two full time newly hired FMS Securities employees, accomplished their first task with much success. The small FMS client seminar was such a...

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Valuation FMS Securities (B) Nicholas and Karina, the two full time newly hired FMS Securities employees, accomplished their first task with much success. The small FMS client seminar was such a success that these clients wanted a second seminar. With this much feedback, James Smith, FMS Securities’ President, assigned them a new task. Their new task consisted of determining Entergy Corp.’s value in common stock, preferred stock, and bonds. With this information, they were to prepare a second seminar to explain the valuation process to the clients. Nicholas and Karina were able to obtain the following information in regard to Entergy Corp.’s long term obligations. The table indicates the first three first-mortgage bonds listed in the Annual Report. Recently, many investors have been gearing away from industrial bonds because of the wave of leveraged buyouts and debt-financed corporate takeovers that took place during the 1980’s. These takeovers were financed through the issuing of large amounts of new debt. This new debt was of high risk and was known to cause the credit rating of the firm’s existing bonds to drop, the required rate of return to increase, and the price of the bonds to decline. After analyzing this, Nicholas and Karina wondered if this would affect Entergy Corp.’s required rate of return on Entergy Corp.’s outstanding bonds. This, however, would not because Entergy Corp.’s bonds are less vulnerable because they are a regulated public utility. Because of this, many investors have turned to government bonds and mortgage backed issues. Nicholas and Karina concluded that the effect of increased concern in regards to any event risk, was to lower Entergy Corp.’s cost of bond financing. The following information was gathered through the use of Value Line Survey. Entergy’s recent price was $38 per share with a P/E of 14.6 and a dividend yield of 4.8%. Its beta was .60. FMS SECURITIES CASE B - Questions 1.) Entergy Corp. has $54,956,000 of preferred stock outstanding. a.) Suppose its Series A, which has a $100 par value and pays a 4.32 percent cumulative dividend, currently sells for $48.00 per share. What is its nominal expected rate of return? It’s effective annual rate of return? (Hint: Remember that dividends are paid quarterly. Also, assume that this issue is perpetual.) b.) Suppose a Series F, with a $100 par value and a 9.75 percent cumulative dividend, has a mandatory sinking fund provision. 60,000 of the 300,000 total shares outstanding must be redeemed annually at par beginning at the end of 2004. If the nominal required rate of return is 8.0 percent, what is the current (January 1, 2004) value per share? 2.) Now consider Entergy Corp.’s common stock. Value Line estimates Entergy Corp.’s 5- year dividend growth rate to be 6.0 percent. Assume that Entergy Corp.’s stock traded on January 1, 2003 for $22.26. Assume for now that the 6.0 percent growth rate is expected to continue indefinitely. a.) What was Entergy Corp.’s expected rate of return at the beginning of 2003? Value Line estimate Entergy Corp.’s dividends to be $1.80 at the start of 2003. b.) What was the expected dividend yield and expected capital gains yield on January 1, 2003? Describe the relationship between dividend yield and capital gains yield over time under constant growth assumptions. 3.) What conditions must hold to use the constant growth (Gordon) model? Do many “real world” stocks satisfy the constant growth assumptions? 4.) Suppose you believe that Entergy Corp.’s 6.0 percent dividend growth rate will only hold 5 years. After that, the dividend growth rate will return to Entergy Corp.’s historical 10-year average of 7.5 percent. Note that D6 = D5 x 1.075. (Use to answer questions 4-8) a.) What was the value of Entergy Corp.’s stock on January 1, 2003 (the end of 2002), if the required rate of return is 13.5 percent? Remember this value you calculate does not have to agree with the market value of $22.26. 5.) a.) What is the expected stock price at the end of 2003 (beginning of 2004) assuming that the stock is in equilibrium? b.) What is the expected stock price at the end of 2004 (beginning of 2005) assuming that the stock is in equilibrium? 6.) What is the expected dividend yield, capital gains yield, and total return for 2003? Hint: You need the expected January 1, 2003 price to compute. 7.) Suppose Entergy Corp.’s dividend was expected to remain constant at $1.80 for the next 5 years and then grow at a constant 6 percent rate. If the required rate of return is 13.5 percent, would Entergy Corp.’s stock value be higher or lower than your answer in Problem 4? 8.) Entergy Corp.’s stock price was $22.26 at the beginning of 2003. Using the growth rates given in the introduction to this question, what is the stock’s expected rate of return? 9.) Based on the information provided in Value-Line Tables is the assumed 6 % growth rate reasonable? What has been the trend? 10.) Given Value-Line’s ROE estimated for 2005 through 2007 and at the projected earnings and dividends per share for the same period. a.) Could those figures be used to develop an estimated long-run “sustainable” growth rate? b.) Does this figure support the 7.5 percent growth rate given in the problem? Hint: Think of the formula g = br = (Retention ratio)(ROE)
Answered 2 days AfterApr 04, 2021

Answer To: Valuation FMS Securities (B) Nicholas and Karina, the two full time newly hired FMS Securities...

Sumit answered on Apr 07 2021
140 Votes
1.
(a).
Given:
Par Value of Stock = $100
Rate of Dividend = 4.32%
Frequency of Dividend = Quarterly
Dividend = $4.32 (100 x 4.32%
)
Current Price of Stock = $48
The formula used to calculate the Current Price of Stock is as under:
Current Price = Annual Dividend / Expected Rate of Return
48 = 4.32 / Expected Rate of Return
Expected Rate of Return = 9%
The formula to calculate the Effective Annual Rate of Return is as under:
((1 + Interest Rate) / Number of compounding) Number of compounding – 1
= ((1 + 0.09) / 4)4 – 1
= 9.94%
(b).
Par Value of Stock = $100
Rate of Dividend = 9.75%
Nominal Rate of Return = 8%
The formula used to calculate the Current Price of Stock is as under:
Current Price = Annual Dividend / Expected Rate of Return
Current Price = 9.75 / 8%
Current Price = $121.875
2.
(a).
Dividend Growth Rate = 6%
Market Price of the Share = $22.26
Dividend per Share at the beginning of 2003 = $1.80
The formula used to calculate the Current Price of Stock is as under:
Current Price = Annual Dividend x (1+ Growth Rate) / (Expected Rate of Return – Growth Rate)
22.26 = 1.80 x (1 + 6%) / (Expected Rate of Return – Growth Rate)
22.26 = 1.908 / (Expected Rate – 6%)
Expected Rate – 6% = 8.60%
Expected Rate = 14.60%
(b).
The formula to calculate the Dividend Yield is as under:
Dividend Amount / Current...
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