Bond & Stock valuation - Case Study

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Bond & Stock Valuation

2. Case Summary
The data
Previous year revenues: + $ 9 billion
Capital structure: 34% Long Term Debt / 3% Preferred Stocks / 63 % Common Stocks
Long-Term Debt Preferred Stock Common Stock
LTD 1: c = 91/8 %, n = 26 years, =$ 930
= 7 years, Premium = $ 104.4375
LTD 2: c = 9%, n = 9 years, = $ 972.50
Par Value = $1000
D= $ 2.75 , Par Val = $30.50
P = $ 30
Voting rights: Only if company is
arrears on 6 or more quarterly
dividends = ¼ vote per share
In case of liquidation: $ 30.50 +
Accumulated dividends
n = 98 million shares
Stock par value = $ 3.125
P= $ 405/8
Quarterly dividend = $ 0.385
g = 9.7 %
Max reinvestment = $ 1000 / month

3. 1. Look at the 91/8 percent coupon bond. What are its
current 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 the
security. This measure looks at the current price of a bond instead of its face value and represents the
return 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 its
current 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 actual
calculation is the same as the Yield to Maturity with the only difference being that instead of using a par
value 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 its
current 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 bond's cash flows equal to its
market 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 maturity
was 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 rate
compare to the YTM for the HPI 91/8 percent bond? Is this difference what you
would 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 related
with the degree of risk. As we know, preferred stocks are riskier than bonds.

9. 5. In the event of liquidation, HPI preferred stockholders are
entitled to $ 30.50 plus accrued dividends. Does this mean
that preferred stockholders will receive that amount?
The preferred stocks are
cumulative which means that the firm
cannot pay the common stocks until
it has paid all its obligations with
accumulated dividends during the
previous periods. One thing it’s sure:
they will paid before common
shareholders but this does not mean
that they will be paid for the entire
amount. They will receive as much
as possible from the liquidation.

10. 6.What are the dividend yield and the expected
capital gains yield for HPI common stock?
Remind : Dividend yield is a financial ratio that shows how much a company pays out in dividends each
year relative to its share price. In the absence of any capital gains, the dividend yield is the return on
investment for a stock.

11. 6. What are the dividend yield and the expected
capital gains yield for HPI common stock?
Remind : Capital gain yield is the price appreciation component of a security's (such as a common
stock) total return. For stock holdings, the capital gains yield will be the change in price divided by the
original (purchase) price.

12. 7. Given that HPI is selling for $ 405/8 what is its required rate
of return?
Remind: Constant growth model (Gordon Model Growth) is a model for determining the intrinsic value
of a stock, based on a future series of dividends that grow at a constant rate. Given a dividend per share
that is payable in one year, and the assumption that the dividend grows at a constant rate in
perpetuity, 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 the
market 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 the
line that reflects an investment's risk versus its
return, or the return on a given investment in
relation to risk. The measure of risk used for the
security market line is beta. The line begins with
the risk-free rate (with zero risk) and moves
upward and to the right. As the risk of an
investment increases, it is expected that the return
on an investment would increase. An investor with
a low risk profile would choose an investment at
the beginning of the security market line. An
investor with a higher risk profile would thus
choose an investment higher along the security
market line.

14. 9. Using the constant growth valuation model, find the present
value 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, the
stock 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 explain
changes in stock prices. Is the model also of value for the actual valuation of stocks?
g = constant
Book theory!
Variable
growth
Dynamic
environment
Variable g:
More
accurate model
Three step model
Variable g:
Difficulties in
calculation

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