On August 1 1998 Georgina Comer CFO of Globalcom Inc was mee

On August 1, 1998, Georgina Comer, CFO of Globalcom Inc. was meeting with the team of investment bankers who were helping Globalcom issue bonds worth $ 6 Billion. The company planned to issue $2 Billion in medium term bonds that will mature in 5 Years and $4 billion in long-term bonds with a maturity of 30 years. Since Globalcom was issuing US dollar denominated bonds, these bonds were expected to make semi-annual coupon payments. The bankers had put together a report on current market trends and the exhibits below provide some of the information that was included in the report that Georgina received. At the time all of Globalcom’s bonds were rated A+ by S&P, but after the issue, it was widely expected that all of Globalcom’s bonds’ ratings would go down to BBB+.

Exhibit 7 –Interest rate on US Government Bonds

Month

Ending

Week Ending

June

July

July

July

July

Yields to Maturity in % per annum

1998

10

17

24

31

3-month

       5.12

       5.08

5.15

5.08

5.07

6-month

       5.32

       5.23

5.23

5.25

5.21

1-year

       5.41

       5.34

5.36

5.36

5.37

2-year

       5.52

       5.43

5.46

5.47

5.48

3-year

       5.52

       5.44

5.48

5.47

5.48

5-year

       5.56

       5.41

5.47

5.47

5.51

7-year

       5.56

       5.47

5.54

5.52

5.56

10-year

       5.50

       5.41

5.49

5.46

5.50

20-year

       5.80

       5.71

5.82

5.79

5.83

30-year

       5.70

       5.61

5.71

5.68

5.73

Exhibit 8 – Spreads (in Basis Points) of Industrial Corporate Bonds over comparable Maturity US treasury Bonds

Exhibit 9: The Value line Forecast of future dividends for Globalcom.

Valueline estimated that the cost of equity for Globalcom was 12% and it estimated that the firm will continue to grow its dividends at a rate of 5% per year forever beyond 2003.

Year

Dividend Per Share ($)

1999

                 $ 1.38

2000

                 $ 1.52

2001

                $ 1.66

2002

                $ 1.78

2003

                 $ 1.80

a. To the nearest cent, what would be your estimate of intrinsic value of Globalcom equity share ?

	Month
	Ending		Week Ending
	June		July	July	July	July
Yields to Maturity in % per annum	1998		10	17	24	31
3-month	5.12		5.08	5.15	5.08	5.07
6-month	5.32		5.23	5.23	5.25	5.21
1-year	5.41		5.34	5.36	5.36	5.37
2-year	5.52		5.43	5.46	5.47	5.48
3-year	5.52		5.44	5.48	5.47	5.48
5-year	5.56		5.41	5.47	5.47	5.51
7-year	5.56		5.47	5.54	5.52	5.56
10-year	5.50		5.41	5.49	5.46	5.50
20-year	5.80		5.71	5.82	5.79	5.83
30-year	5.70		5.61	5.71	5.68	5.73

ndusthiall Issues 31-Jl98 13 31 13 84. 100 1OT 120 12B 149 51 75 85 65 71 81 110 100 114 1GA 64 76 127 142 Compied fom aerages of bonds rated by Standard& Poor\'s. Fno data is gven, it implies Standard & Poor\'s rates no bonds in that categry Abasis pont is 0.01% or 0-0001-One hunded basis ports (bps) equal 1.0%

Solution

Answer:-

Intrisic Value of Stock can be know from Dividend Discount Model (DDM) as we have been given future dividend from year 1999 to 2003 and we are in year 1998 (as given in start of question).

Cost of Equity is estimated to be 12% which we would be taking as required rate of return for DDM formula.

Intrinsic Value of Stock as per DDM is =

[Dvidend of Year 1999/(1+12%)^1] + [Dvidend of Year 2000/(1+12%)^2] + [Dvidend of Year 2001/(1+12%)^3] + [Dvidend of Year 2002/(1+12%)^4] + [Dvidend of Year 2003/(1+12%)^5]

=[($1.38) / (1.12)^1] + [($1.52) / (1.12)^2] + [($1.66) / (1.12)^3] + [($1.78) / (1.12)^4] + [($1.80) / (1.12)^5]

= $1.23 + $1.212 + $1.181 + $1.131 + $1.022 = $5.776

Intrisic Value of the stock = $5.776 or $5.78