Finance Mini Case Chapter 7

Temp Force Company

a. Legal rights and privileges of common stockholders.

The common stockholders are the owners of a corporation, and as such they have certain rights and privileges.

* Control of the firm: Common stockholders have the right to elect the company’s directors.

* The Preemptive Right: Common stockholders have the right to purchase any additional shares sold by the company. Enables current stockholders to maintain control, and it prevents the transfer of wealth from current stockholders to new stockholders.

b. 1. Formula that can be used to value any stock, regardless of its dividend pattern.

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b. 2. What is a constant growth stock? How are constant growth stocks valued?

A constant growth stock is one whose dividends are expected to grow at a constant rate forever. Many companies have dividends which are expected to grow steadily into the future, and such companies are valued as constant growth stocks.

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b. 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? In the long run?

A necessary condition for the Constant Growth model is that rs is greater than g. If g is greater than rs, the model gives a negative stock price.

The Constant Growth model cannot be used unless:

* rs > g

* g is expected to be constant

* g can reasonably be expected to continue indefinitely.

Stocks may have periods of supernormal growth, where gs > rs; however, this growth rate cannot be sustained indefinitely. In the long-run, g < rs.

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?

rs= rRF + (rM – rRF)b

rs = 7% + (12% - 7%) (1.2)

rs = 7% + (5%)(1.2)

rs = 7% + 6%

rs = 13%

d. Assume that Temp...