Sam Strother and Shawna Tibbs are senior vice presidents of Mutual of Seattle. They are co-directors of the company's 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 cities in the association, 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 supplies 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
(2.) What is a constant growth stock? How are constant growth stocks valued?
(3.) What happens if a company has a constant g which 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 percent, and that the market risk premium is 5 percent. What is the required rate of return on the firm's 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 percent rate.
d (1.) What is the firm's expected dividend stream over the next 3 years?
d (2.) What is the firm's current stock price?
d (3.) What is the stock's expected value one year from now?
d (4.) What are the expected dividend yield, the capital gains yield, and the total return during the first year?