CASE 72M STUDENT MODEL 9/28/96

SWAN-DAVIS, INC.
Bond and Stock Valuation
The model-generated portion oI this Iile can actually be divided into 4 separate parts:
cost oI debt and bond valuation, cost oI preIerred stock, cost oI equity/common stock
valuation, and convertible bond valuation. The model uses inputs provided in the input
data section to calculate the yields to maturity and call on the 10-yr. SDI bond, and the
yield to call and the bond price on the 23-yr. SDI bond. In addition, the cost oI SDI's
preIerred stock is calculated as well as the aIter-tax returns to both an individual and a
corporation investing in SDI's preIerred stock. The corporation's cost oI equity is
calculated using three diIIerent methodologies: DCF (using Tony Biddle's dividend and
price proiections), nonconstant DCF, and bond-yield-plus-risk-premium. ERRs that
appear in student models are due to blank cells.
The Iollowing cells have been blanked out:
C94, C124, B135, C185, E205, C213, G259, C32, F120, C125, B152, E161, E164, and C182.

INPUT DATA: OUTPUT DATA:
Bonds: Bonds:
Par value, both bonds $1,000.00 YTM, 10-yr SDI bond 8.61
A (10-yr) bond price $1,092.00 YTC, 10-yr SDI bond 0.00
A (10-yr) bond coupon 10.00
A (10-yr) call price $1,040.00 23-yr SDI bond price $2,587.00
B (23-yr) bond coupon 6.90 YTC, 23-yr SDI bond -6.21
B (23-yr) call price $1,100.00
B (23-yr) k(d)
PreIerred Stock: PreIerred Stock:
PreIerred dividend $8.25 k(ps) SDI 8.51
PreI. stock price $97.00 AT return to indiv. 0.00
Individual tax rate 39.60 AT return to corp. 0.00
Corporate tax rate 40.00
Corp. div. exclusion 70.00
Common Stock: Common Stock:
1996 EOY stock price $15.00 kM (Ior reIerence) 0.00
Supernrmal g in div. 20.00
D(0) (Table 2) $0.52 ks Calculations:
EPS (0) (Table 2) $1.07 Nonconstant DCF 0.00
D(1): 1997 (Table 5) $0.20 CAPM, LT kRF -2.44
D(2): 1998 " $0.24 CAPM, ST kRF 5.20
D(3): 1999 " $0.29 CAPM, Ibbotson 16.60
D(4): 2000 " $0.35 kd RP (Ibbotson) 6.40
D(5): 2001 " $0.41 Text: kdRP (Low) 2.00
P(5): 2000 " $30.20 Text: kdRP (High) 6.00
Constant g, g(N) 14.90
Avg. stock's div. yld. 2.40 (Irom Value Line)
Avg. stk's 4-yr gain 55.00 "
Risk premium, ks - kd 6.40 (Irom Ibbotson)
Risk prem, kM - k(RF) 7.50 (Irom Ibbotson)
Risk-Iree rate, L-T: 6.10 Given in case
Risk-Iree rate, S-T: 5.20 Given in case
Convertibles: Convertibles:
Par value: $1,000.00 kC, beIore-tax -6.01
Coupon rate: 7.00 kC, aIter-tax 0.00
Years to maturity: 15
Shares received: 40
Call price: $1,050.00
Years to call: 10
Premium to call: 30.00
MODEL-GENERATED DATA: Cost oI Debt and Bond Valuation
A (10-yr.) bond: B (23-yr.) bond:
6-month CF iI CF 6-month CF iI not CF
period not called iI called period called iI called
------------------- ----------------- ------------------- ----------------- ----------------- -----------------
0 (1,092.00) (1,092.00) 0 0.00 (2,587.00)
1 50.00 50.00 1 34.50 34.50
2 50.00 50.00 2 34.50 34.50
3 50.00 50.00 3 34.50 34.50
4 50.00 1,090.00 4 34.50 34.50
5 50.00 5 34.50 34.50
6 50.00 6 34.50 34.50
7 50.00 7 34.50 34.50
8 50.00 8 34.50 34.50
9 50.00 9 34.50 34.50
10 50.00 10 34.50 1,134.50
11 50.00 11 34.50
12 50.00 12 34.50
13 50.00 13 34.50
14 50.00 14 34.50
15 50.00 15 34.50
16 50.00 16 34.50
17 50.00 17 34.50
18 50.00 18 34.50
19 50.00 19 34.50
20 1,050.00 20 34.50
YTM 8.61 21 34.50
YTC 22 34.50
23 34.50
24 34.50
25 34.50
26 34.50
27 34.50
28 34.50
29 34.50
30 34.50
31 34.50
32 34.50
33 34.50
34 34.50
35 34.50
36 34.50
37 34.50
38 34.50
39 34.50
40 34.50
41 34.50
42 34.50
43 34.50
44 34.50
45 34.50
46 1,034.50
NPV $2,587.00
YTC -6.21
PREFERRED STOCK:
Cost oI preI. stock 8.51
AT return to indiv.
AT return to corp.
COMMON STOCK:
Calculate ks using DCF Method and Tony Biddle's cash Ilow proiections:
Time Line: 1996 1997 1998 1999 2000 2001
Dividend 0.52 0.20 0.24 0.29 0.35 0.41
Price -15.00 30.20
----- ---- ---- ---- ---- -----
Cash Flow -15.00 0.20 0.24 0.29 0.35 30.61
DCF ks
NON-CONSTANT DCF MODEL:
The non-constant DCF model is used as Iollows: Insert a "reasonable"
estimate oI the non-constant DCF cost oI equity in the cell Ior "Non-C
DCFk"; you must change this value later. Then the model Iorecasts
dividends in column C below, Iinds the PV oI the dividends discounted
at the rate you inputted Ior "Non-C DCFk," Iinds the stock price at the
end oI the non-constant growth period as D6/(k-g), Iinds the PV oI that
price, sums the PVs oI the dividends during the non-constant growth
period, and adds to this sum the PV oI the terminal stock price, P5, to
obtain the "Calculated price." The initial calculated price will not
equal the actual current price except by luck. You must change the
value in the DCF k cell until the calculated price is approximately
equal to the actual price to get the expected rate oI return.
MANUAL NON-CONSTANT DCF K MODEL: (plus/minus 5 cents is close enough!)
Non-C DCFk: Calculated price: $1.07
(increase value iI Actual price: $15.00
calc price ~ act. price) EOY Stock
Growth rate: Dividends: PV oI DIVS: Price:
0 $0.520 $15.00
1 0.200 $0.2000 1.29
2 20.0 0.240 0.2400 1.05
3 20.0 0.288 0.2880 0.76
4 20.0 0.346 0.3456 0.41
5 20.0 0.415 0.00
6 14.9 0.477 -----------------
Sum oI PV oI divs, 1-5: $1.0736
P(5) sum PV oI DIVS beyond Yr 5:
PV oI P(5) $0.0000
-----------------
Calculated price PV div PV P(5) $1.0736

Note: Since Tony Biddle's estimates are used as inputs Ior this model,
the estimate obtained should be the same as that derived using the
time line approach and Excel's IRR Iunction.
CAPM APPROACH:
k(RF), L-T: 6.10
k(RF), S-T: 5.20
k(M) Calculation:
N 4 Value Line's Iorecast period.
PV $1.00 Beginning index oI average stock.
FV $1.55 Ending index iI 55 appreciation.
I Avg. stock's g Rate that gets $1 to $1.55 in 4 years.
Avg. stock's div. yld. 2.40 Given in Value Line Report.
-------------------
k(M)

BETA CALCULATION: Year SDI Market

Regression Output: 1 25.64 30.50
Constant 0.055668915 2 10.34 7.70
Std Err oI Y Est 0.404605947 3 46.97 10.00
R Squared 0.001647618 4 -34.96 2.00
No. oI Observations 5 5 -28.35 35.60
Degrees oI Freedom 3
X CoeIIicient(s) -0.095506498 calculated beta coeIIicient versus
Std Err oI CoeI. 1.357331569 1.1 to 1.3 industry average.
Beta based on industry average range oI 1.1 to 1.3: 1.4
CAPM ks ESTIMATES:
ks: calc b, LT kRF: 6.10 0.58 6.68
ks: indus b, LT kRF: 6.10 -8.54 -2.44
ks: calc b, ST kRF: 5.20 0.50 5.70
ks: indus b, ST kRF: 5.20 5.20
ks: indus b, Ibbotson: 6.10 10.50 16.60
Note: The negative beta CAPM estimates are nonsense. The reasonable
CAPM estimates range Irom 16.60 to 17.49.
RISK PREMIUM METHOD:
Calculate ks using kd RP:
SDI's bond yld, kd: Based on analysis in case.
Ibbotson RP: 6.40 Ibbotson.
------
ks kd RP 6.40

2.00 low end oI ks range.
6.00 upper end oI ks range.
CONVERTIBLE BOND ANALYSIS
This model Iinds the rate oI return an investor would expect to earn
on convertible bonds. First, it Iinds the value oI the bonds as
straight debt over time. Next, it Iinds the value oI the bonds iI they
were converted at each point in time. The conversion value is a
Iunction oI the stock price, which is expected to grow. The stock
prices over time could be estimated in various ways; we used the
inIormation derived in the nonconstant growth section oI the model
above, then increased stock price at 14.9 aIter Year 5.
An investor would have to pay $1,000, then would receive interest
until the bonds were called, and then would get the conversion
value. The IRR oI this cash Ilow stream is the expected rate oI return
to the investor and the beIore-tax cost to the company. II the terms
oI the convertible change enough to cause a change in the year
conversion occurs, then it would be necessary to modiIy the IRR range
manually.
SDI's
Cost II SDI's
Beginning Bond CF to Straight Value iI Converted AIter-tax
oI Year Maturity debt value Convert Year 10 Cost
0 (1,000) 2,050.00 600.00 (1,000.00) (1,000.00)
1 70 1,980.00 51.53 70.00 42.00
2 70 1,910.00 41.93 70.00 42.00
3 70 1,840.00 30.41 70.00 42.00
4 70 1,770.00 16.59 70.00 42.00
5 70 1,700.00 0.00 70.00 42.00
6 70 1,630.00 0.00 70.00 42.00
7 70 1,560.00 0.00 70.00 42.00
8 70 1,490.00 0.00 70.00 42.00
9 70 1,420.00 0.00 70.00 42.00
10 70 1,350.00 0.00 70.00 42.00
11 70 1,280.00 0.00
12 70 1,210.00 0.00
13 70 1,140.00 0.00
14 70 1,070.00 0.00
15 1,070 1,000.00 0.00
IRR Cost Rate -6.01
The convertible provides relatively certain interest payments plus
relatively risky capital gains. Straight bonds provide all relatively
sure cash Ilows, and common stock provides more risky cash Ilows. So,
a convertible's risk is between a straight bond and common stock, so the
rate oI return on a convertible should be between that on straight
bonds and common stock. ThereIore, the convertible seems reasonably
priced.
We also determine the convertible's aIter-tax cost by reducing
each interest payment by (1-T), but leaving the conversion value
alone, and Iinding the IRR, which is the aIter tax-cost cost oI the
convertibles. That value could be used to Iind a new WACC, iI we had
adequate inIormation.

END