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FIN 320

Fall 2018

 Project Completion Instructions.

Will identify a public company that has at least two bond issues outstanding.  One bond should have about five years to maturity and the other should have about fifteen years to maturity.  You will also identify two US Treasury instruments, each maturing at about the same time as each of the corporate bonds.

You will keep track of the S&P 500 index, the company’s stock price, the bond prices and their yields to maturity at least twice weekly.  You will compute the spreads of the two bonds and changes over the period of your observation. (The spread is the difference between the yield to maturity (YTM) on the corporate bond and the YTM on the comparable Treasury issue.) Data collection should proceed through Nov. 16.   You will be collecting a fair amount of data over the period of observation and you will be required to interpret this data and see what the data is telling us.

• For the two corporate bonds, the two matching Treasury instruments, the stock price and the S&P 500 index, calculate the standard deviation of prices. Divide that standard deviation by the mean to give a measure of risk that you can use to compare all six of these.  Rank all of these from lowest to highest risk.  Is this the order you anticipated?
• What are the credit spreads on the short term and longer term bonds? Do they seem compatible with the ratings of the bonds (provide ratings from the 3 agencies).
• Collect the start and end stock prices in each of the last 5 calendar years ending in December 2017 as well as the cash dividends paid each year. Using the DDM, calculate the required rate of return on equity (R).

For the DDM, R = Dividend yield + Capital Gain yield

Div. yield = Div₁/P_o

Capital Gain yield = (P₁ – P₀)/P₀

Calculate R for each of the 5 years ending  in 2017 and calculate the arithmetic average.

Use CAPM to calculate a required rate of return.  Use a risk free rate of 2% and a market risk premium of 7%.  Which of these two returns do you believe is more realistic and why?  You will use that rate for the calculations that follow.

• With the annual dividend information for the last 5 years recorded in 3 above, calculate the annual growth rate and compute the arithmetic average.
• Using data from the last five years, calculate the averages of the Internal Growth rate [ROA x b/(1 – ROA x b)] and the Sustainable Growth rate [ROE x b/(1 – ROE x b)] [p. 71 to 72]. How do these compare with the growth rate calculated in #4 above?
• Using book values as of the last reported year end (see 10K report), calculate the leverage ratio [long term debt /(long term debt + equity)]
• Calculate the company’s weighted average cost of capital (WACC). Use market values for debt (face value of each bond times price to obtain a market value) and equity (market capitalization).  For the cost of debt, use the weighted average yield to maturity. [ See section 13.10 in the textbook, “Estimating Eastman’s Chemical Cost of Capital”.]
• Using the DDM for constant growth, calculate the growth rate in dividends implied in the stock price [Price = Div₁/(R – g)]. Solve for g using current stock price, the R you calculated in #3 above and the projected annual dividend obtained by applying the dividend growth rate to 2017’s dividend.
• Calculate NPVGO from the relationship NPVGO = Price of stock – value of the firm as a cash cow (Div/R). What is this as a percent of stock price?
• Calculate the firm’s investment in fixed assets over the last 5 years. How does that compare to depreciation over that period? How much external funding has the firm obtained over the last 5 years?  How has the leverage ratio evolved?
• As of the last year end, what is a.) the EBITDA to interest ratio[cash coverage ratio]and b.) the Interest-bearing debt to EBITDA (p. 51 to 52)?
• Calculate Market Value to Book ratio and Enterprise Value to EBITDA as of last year end (p. 55 – 56).

Using the above information, how would you characterize management’s strategy for growth?  How have they chosen to finance growth?How do they use leverage?  Do they appear to have a target value for leverage and, if so, what is it?  How effective have they been in generating shareholder value over the last five years?  What was the holding period return (HPR) over the last 5 years?

You may include any other insights or comments that arise from this data and analysis.