Posted in (Adapted from 1995 CFA Level I1 exam) Your supervisor has asked you to evaluate the relative attractiveness of the stocks of two very similar chemical companies: Litchfield Chemical Corp. (LCC) and Arninochem Company (AOC). AOC and LCC have June 30 fiscal year ends. You have compiled the data in Exhibit 17-1 for this purpose. Use a one-year time horizon and assume the following:
- Real gross domestic product is expected to rise 5 percent;
- S&P 500 expected total return of 20 percent;
- U.S. Treasury bills yield 5 percent; and
- 30-year U.S. Treasury bonds yield 8 percent.
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EXHIBIT 17-1 Selected Data for Litchfield and Aminochem |
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Litchfield Chemical |
Aminochem |
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Current stock price |
$50 |
$30 |
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Shares outstanding (millions) |
10 |
$20 |
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Projected earnings per share (N 1996) |
$4.00 |
$3.20 |
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Projected dividend per share (EY 1996) |
$0.90 |
$1.60 |
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Projected dividend growth rate |
8% |
7% |
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Stock beta |
1.2 |
1.4 |
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Investors” required rate of return Balance sheet data (millions) |
10% |
11% |
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Long-term debt |
$100 |
$130 |
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Stockholders” equity |
$300 |
$320 |
A. Calculate the value of the common stock of LCC and AOC using the constant growth DDM. Show your work.
B. Calculate the expected return over the next year of the common stock of LCC and AOC using the CAPM. Show your work.
C. Calculate the internal (implied, normalized, or sustainable) growth rate of LCC and AOC. Show your work.
D. Recommend LCC or AOC for investment. Justify your choice using your answers to A, B, and C and the information in Exhibit 17- 1.
