# Case 78 Questions McDaniel Nienberg Palmer Pastor

1.According to ValueLine estimates in Figure 1, James River’s expected annual dividend growth rate from the 91–93 to 97–99 period is 5.50%, and the next dividend (1995) is expected to be $0.60. Assume that the required return for James River was 8.36% on January 1 1995 and that the 5.50% growth rate was expected to continue indefinitely.

a.Based on the Constant Growth Rate or Gordon Model, what was James River’s price at the beginning of 1995?

b.What conditions must hold to use the constant growth model?

c. Do many “real world” stocks satisfy the constant growth assumptions?

2.The Wall Street Journal (WSJ) lists the current price of James River common stock at $27.00.

a.Based on this information, the ValueLine 1995 expected dividend, and the annual rate of dividend change for the growth estimate,

what is the company’s return on common stock using the constant growth model?

What is the expected dividend yield and expected capital gains yield?

Explain the difference in the required return estimates from the ValueLine (see question 1a) to the WSJ price data.

b.What is the relationship between dividend yield and capital gains yield over time under constant growth assumptions?

3.A successful joint venture is expected to result in the 4.0% growth rate until 2000 but would increase the company’s normal growth rate to a constant 8.00% after that time. The joint venture also is expected to increase investors’ required return to 9.50%.

a.Based on this information, what is the value of the company’s stock?

b.What is the value of the stock at the end of the first year assuming that the stock is in equilibrium?

c.What is the dividend yield, capital gains yield, and total yield of the stock for the year? If you are using the spreadsheet model for this case, discuss the changes in dividend yields and capital gains yields over time.

4.One method of determining the company’s growth rate is from the fundamentals of the retention ratio and return on retained earnings. How does the growth rate—based on ValueLine’s 1997–1999 estimated retention ratio (Hint: use 1 – % all dividends to net profit) and expected return on retained earnings of 10.5%—affect the return on the stock as compared to the initial return found in question 2?

5.Using the yields for the 10 year T–bond from The Wall Street Journal, an annual average risk premium of stock over risk free treasuries of 6.20%, and the beta from ValueLine,

what is the required return on the stock based on the CAPM?

How does this return compare to the return found in question 2?

6.Answer the following questions on preferred stock using The Wall Street Journal stock information.

a.What is the nominal expected rate of return for James River series K preferred stock? (Hint: Preferred stock pays a quarterly dividend)

What is the effective annual rate?

b.What is the value of the preferred stock if it has a sinking fund in which 20% of the initial issue of stock was redeemed annually at par ($100) and the required nominal return is 9.76%?

7.Answer the following questions concerning James River debt using the S&P Bond Guide Information.

a.Why do the coupon rates of James River debt vary so widely?

b.Based on the required returns of 8.5% and 9% for similar short term and long term bonds respectively, what are the values of the semiannual coupon bonds and notes held in Ms. Peabody’s portfolio?

Are the bonds and notes selling at a discount or a premium?

8.Based on the bond analysts current expected prices of the company’s debt,

what is the nominal yield to maturity of each issue in the portfolio?

What is the effective annual rate?

Would you expect a semiannual payment bond to sell at a higher or lower price than an otherwise equivalent annual payment bond? Explain why.

9.Assume that James River Corporation’s anticipated new 28 year 12% bond is not...

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