Soln_Ch8_MiniCase - INTEGRATED CASE Mutual of Chicago...

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Mutual of Chicago Insurance Company Stock Valuation 8-27 ROBERT BALIK AND CAROL KIEFER ARE SENIOR VICE-PRESIDENTS OF THE MUTUAL OF CHICAGO INSURANCE COMPANY. THEY ARE CO-DIRECTORS OF THE COMPANY’S PENSION FUND MANAGEMENT DIVISION, WITH BALIK HAVING RESPONSIBILITY FOR FIXED INCOME SECURITIES (PRIMARILY BONDS) AND KIEFER BEING RESPONSIBLE FOR EQUITY INVESTMENTS. A MAJOR NEW CLIENT, THE CALIFORNIA LEAGUE OF CITIES, HAS REQUESTED THAT MUTUAL OF CHICAGO PRESENT AN INVESTMENT SEMINAR TO THE MAYORS OF THE REPRESENTED CITIES, AND BALIK AND KIEFER, WHO WILL MAKE THE ACTUAL PRESENTATION, HAVE ASKED YOU TO HELP THEM. TO ILLUSTRATE THE COMMON STOCK VALUATION PROCESS, BALIK AND KIEFER HAVE ASKED YOU TO ANALYZE THE BON TEMPS 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. ANSWER: [SHOW S8-1 THROUGH S8-5 HERE.] THE COMMON STOCKHOLDERS ARE THE OWNERS OF A CORPORATION, AND AS SUCH THEY HAVE CERTAIN RIGHTS AND PRIVILEGES AS DESCRIBED BELOW. 1. OWNERSHIP IMPLIES CONTROL. THUS, A FIRM’S COMMON STOCKHOLDERS HAVE THE RIGHT TO ELECT ITS FIRM’S DIRECTORS, WHO IN TURN ELECT THE OFFICERS WHO MANAGE THE BUSINESS. 2. COMMON STOCKHOLDERS OFTEN HAVE THE RIGHT, CALLED THE PREEMPTIVE RIGHT, TO PURCHASE ANY ADDITIONAL SHARES SOLD BY THE FIRM. IN SOME STATES, THE PREEMPTIVE RIGHT IS AUTOMATICALLY INCLUDED IN EVERY CORPORATE CHARTER; IN OTHERS, IT IS NECESSARY TO INSERT IT SPECIFICALLY INTO THE CHARTER. Integrated Case: 8 - 1 INTEGRATED CASE
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B. 1. WRITE OUT A FORMULA THAT CAN BE USED TO VALUE ANY STOCK, REGARDLESS OF ITS DIVIDEND PATTERN. ANSWER: [SHOW S8-6 HERE.] THE VALUE OF ANY STOCK IS THE PRESENT VALUE OF ITS EXPECTED DIVIDEND STREAM: 0 P ˆ = . ) k 1 ( D ) k 1 ( D ) k 1 ( D ) k 1 ( D s 3 s 3 s 2 t s 1 + + + + + + + + HOWEVER, SOME STOCKS HAVE DIVIDEND GROWTH PATTERNS THAT ALLOW THEM TO BE VALUED USING SHORT-CUT FORMULAS. B. 2. WHAT IS A CONSTANT GROWTH STOCK? HOW ARE CONSTANT GROWTH STOCKS VALUED? ANSWER: [SHOW S8-7 AND S8-8 HERE.] A CONSTANT GROWTH STOCK IS ONE WHOSE DIVIDENDS ARE EXPECTED TO GROW AT A CONSTANT RATE FOREVER. “CONSTANT GROWTH” MEANS THAT THE BEST ESTIMATE OF THE FUTURE GROWTH RATE IS SOME CONSTANT NUMBER, NOT THAT WE REALLY EXPECT GROWTH TO BE THE SAME EACH AND EVERY YEAR. MANY COMPANIES HAVE DIVIDENDS THAT ARE EXPECTED TO GROW STEADILY INTO THE FORESEEABLE FUTURE, AND SUCH COMPANIES ARE VALUED AS CONSTANT GROWTH STOCKS. FOR A CONSTANT GROWTH STOCK: D 1 = D 0 (1 + g), D 2 = D 1 (1 + g) = D 0 (1 + g) 2 , AND SO ON. WITH THIS REGULAR DIVIDEND PATTERN, THE GENERAL STOCK VALUATION MODEL CAN BE SIMPLIFIED TO THE FOLLOWING VERY IMPORTANT EQUATION: 0 P ˆ = g k D s 1 - = g k ) g 1 ( D s 0 - + .
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Soln_Ch8_MiniCase - INTEGRATED CASE Mutual of Chicago...

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