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James Smith and Roberta Jones are vice-presidents of van den Berg Money Management Inc. (VDBMM), providing pension fund management services to municipalities in the New York metropolitan area. They are in the process of putting together a presentation for a new client, the NY Consortium of Cities (NYCC) and hope to convince the client that they can do a superb job of handling their investments for them. Smith is very conservative and feels that a bond strategy is best, while Jones is more aggressive and believes that a stock strategy is best considering the recent economy and how well the market has done.

Your assignment is to assist Mr. Smith and Ms. Jones in preparing the presentation for the client. You believe that a combination of both strategies might be best and would like to integrate this into the presentation as much as you can.

You are going to include some examples, including:

A stock that is constant growth whose last dividend (paid yesterday) was $1.50 and whose dividend is expected to grow indefinitely at 4%:

a. The earnings and dividends are expected to decline by a constant 6% per year. Why might someone consider buying this stock, and at what price would it sell?

b. Assume that the company in b above decides to embark on an aggressive expansion that requires additional capital. Management decides to finance the expansion by borrowing $40 million and by halting dividend payments to increase retained earnings. The projected free cash flows for the next 3 years are -$5 million (negative), $10 million and $20 million. After the third year, free cash flow is expected to grow at a constant 6%. The overall cost of capital is 10 percent. What would be the total value of the company? If it has 10 million shares of stock and $40 million in total debt, what is the price per share?

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