Based on the information that you have, what should the per share value of Game Tech’s common stock be, assuming that dividends will continue to grow at a constant rate?
For this assignment you will be provided with information regarding a fictitious organisation and required to perform equity and bond valuations. Provide the answer for each part as well as the equations used.
Game Tech is an organisation that develops and manufactures video games for various gaming systems. The video gaming industry in which Game Tech competes is marked by rapid growth as new delivery systems are being developed. The firm currently has 1 million shares of common stock outstanding. Game Tech has recently hired you as their financial analyst. Your first assignment is to find the per share value of the firm’s common stock.
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Because you were just hired, you have had to complete some research into the company’s past financial performance. A review of Game Tech’s prior year financial reports reveals that the firm had paid out a total of £1,500,000 in dividends (the number of share outstanding has not changed since that time). In speaking with the CFO, Game Tech has a required return on 25% and the CFO has also stated that he believes that the firm will have a constant growth rate of 20%.
1. Based on the information that you have, what should the per share value of Game Tech’s common stock be, assuming that dividends will continue to grow at a constant rate? (done don’t need to to)
2. After providing the per share value to the CFO, you are not satisfied that the information you used is completely reliable. You decide to further research the gaming industry, its potential growth opportunities and the future innovations that Game Tech is developing. You believe that the organisation cannot sustain such a high growth rate indefinitely, especially given the fact that new firms are entering the industry. The firm will continue to grow at 20% for the next five years. After that, Game Tech will encounter more competition and the gaming technology will become more widespread, which is forecasted to lower the growth rate of the organisation to 10%. This growth rate will then be sustained indefinitely. Based on this information, what is the per share value of Game Tech’s common stock? (done don’t need to to)
3. The CFO agrees with your research, however, he is concerned as the technology being developed carries more risk. He wants to know if the current discount rate of 25% is appropriate. What will you tell your boss?
4. The firm has also issued bonds for long-term financing purposes. Currently the bond is selling at a discount of £95.91 (£100 par value) on the open bond market. The bond makes semi-annual coupon payments at a coupon rate of 6%, and will mature in 5 years. A colleague does not understand why the bond is selling for less than its par value. How would you explain this to her? Support your explanation by including the equation for how the market price would be calculated. What is the current market rate expressed on an annual basis?
5. If the organisation were considering issuing a new bond today, explain what coupon rate the firm should theoretically offer. Assume the newly issued bond would have the same characteristics of the previously issued one.