Your employer, a mid-sized human resources management company, is considering ex

Question

Your employer, a mid-sized human resources management company, is considering expansion into related fields, including the acquisition of Temp Force Co. an employment agency that supplies word processor operators and computer programmers to business and temporary heavy workloads. Your employer is also considering the purchase of a Biggerstaff & Biggerstaff (B&B), a privately held company owned by two brothers, each with 5 million shares of stock. B&B's financial statements report marketable securities of $100 Million, debt of $200 Million, and preferred stock of $50 million. B&B's WACC is 11%.

     A) 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 6% rate.

(1) What is the firm’s current estimated intrinsic stock price?

     B) Why are stock price volatile? Using Temp Force as an example, what is the impact on the estimated stock price if g falls to 5% or rises to 7% if rs changes to 12% or to 14%?

Explanation / Answer

A) Current stock price = D0(1+growth) /(WACC -growth)

                                 = 2(1+.06) /(.11-.06)

                                 = 2.12 / .05

                                 = $ 42.40 per share

B) If growth = 5% ,WACC= 12%

Current price = 2(1+.05) /(.12-.05)

                    = 2.10 / .07

                    = $ 30 per share

If Growth is 7% ,WACC= 14%

current price = 2(1+.07)/(.14-.07)

                   = 2.14 / .07

                    = $ 30.57 per share.

we can the price of a stock fluctuates with change in growth rate and WACC(cost of capita).

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