Stock Valuation
Peachtree Securities, Inc. (B)
Laura Donahue, the recently hired utility analyst for Peachtree Securities, passed her first assignment with flying colors. After presenting her seminar on risk and return, any customers where clamoring for a second lecture. Therefore, Jake Taylor, Peachtree’s president, gave
Donahue her second task: determine the value of TECO Energy’s securities (common stock, preferred stock, and bonds) and prepare a seminar to explain the valuation process to the firm’s customers. To begin, Donahue reviewed the Value Line Investment Survey data. Next Donahue examined
Teco’s latest Annual Report, especially Note E to the Consolidated Financial Statements. This note lists TECO’s long-term debt obligations, including its first- mortgage bonds, installment contracts, and term loans. Table 1 contains information on three of the first-mortgage bonds listed in the Annual Report.
Table 1
Partial Long Term Debt Listing for TECO Energy
Face Amount Coupon Rate Maturity Year Years to Maturity
$ 48,000,000 4 1/2% 1997 5
32,000,000 8 ¼ 2007 15
100,000,000 12 5/8 2017 25
Note: The terms stated here are modified slightly from the actual terms to simplify the case.
A concern which immediately occurred to Donahue was the phenomenon of “event risk.”
Recently, many investors have shied away from the industrial bond market because of the wave of leveraged buyouts (LBOs) and debt-financed corporate takeovers that took place during the
1980s. These takeovers were financed by issuing large amounts of new debt—often high-risk
“junk” bonds—which caused the credit rating of the firm’s existing bonds to drop, the required rate of return to increase, and the price of the bonds to decline.
Donahue wondered if this trend would affect the required returns on TECO’s outstanding bonds. Upon reflection she concluded that TECO’s bonds would