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QUESTION 3 Problem Set #7

Golden Enterprises Inc. is a producer of medical pumps. The company’s stock price dropped 15% last year due to worsening financial ratios and declining market share. The company is insolvent because its liabilities exceed the market value of its assets, and it does not have enough cash to meet its interest and principal payments. The stockholders are worried and threatening to vote out the management of the company and replace them with new ones. The board of directors of the company has asked the Chief Finance Officer, Christopher Valentine, MBA to address certain concerns as an outside group is soliciting proxies to overthrow management and take control of the business. The board wants to know how much the company is worth, what can be done to make the company more valuable, why stock price of the company is so volatile, and if it is possible to stop the outside group from taking over the business.

1. Explain the following terms to the management of Golden Enterprises:

i. proxy fight

ii. preemptive right

2. Identify and explain two main sources of entity value.

3. The most recent free cash flow (FCF) for Golden Enterprises was $200 million, and the management expects the free cash flow to begin growing immediately at a 7% constant rate. The cost of capital is 12%.

i. Using the constant growth model, determine the value of operations for Golden Enterprises Inc.

Golden Enterprises Inc. balance sheet shows that it has $10 million short-term investments, $15 million in notes payable, $60 million in long-term bonds, and $15 million in preferred stock. Golden Enterprises has 60 million of shares outstanding. Calculate the following:

ii. total intrinsic value for Golden Enterprises Inc.

iii. intrinsic value of equity for Golden Enterprises Inc.

iv. intrinsic stock price per share for Golden Enterprises Inc.

4. Another company in the medical equipment industry, Watkins Inc. is expected to have free cash flow (FCF) of $105 million next year and an expected constant growth rate of 5% thereafter. The weighted average cost of capital (WACC) for the company is 9.0%. Using the constant growth model, estimate the value of operations for Watkins Inc.

5. Golden Enterprises Inc. is expected to pay a $4.50 per share dividend at the end of this year (i.e., D1 = $4.50). The dividend is expected to grow at a constant rate of 5% a year. The required rate of return on the stock is, rs, is 9.2%. Using the constant dividend growth model, what is the estimated value per share of the company’s stock?

6. Golden Enterprises has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred stock sells for $50 a share. Calculate the preferred stock’s required rate of return.

7. Boehm Incorporated currently pays a dividend of $2 per share (D0 = $2). It is estimated that the company’s dividend will grow at a rate of 20% per year for the next 2 years and then at a constant rate of 7% thereafter. The company’s stock has a beta of 1.2, the risk-free rate is 7.5%, and the market risk premium is 4%. Calculate the estimated current price of the stock.

Submit your answers in a Word document.

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