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Finc Case Study - Financial Markets Homework Help
Finc Case Study - Financial Markets Homework Help
GilbertCaseStudyexampleofwriteup.docx
a. Current Situation
( Company I nformation )Gilbert Enterprises, the third largest publicly traded firm in the auto parts
replacement industry, had experienced a decline in its stock price over the past five months. Its founder
and chairman, Tom Gilbert, along with the Finance VP, were considering a stock repurchase, thinking
the announcement would send a message to investors about the current market undervaluation of the
stock.
( Industry and Economic Information )Research had indicated that auto owners were keeping their
vehicles longer (8 years on average, up from 6.8 years twenty years earlier), and new vehicle price
increases had surpassed the rise in consumer incomes. The trend of investing in older vehicles to keep
them on the road longer would bode well for Gilbert. In addition, Gilbert had invested in an industry-
leading JIT inventory management system and as a result expected supernormal growth over the next
several years.
b. Major Issues
· ( Develop these issues preliminarily, and readdress/refine them after answering the case-specific
questions )Does the growth rate seem reasonable, given the current and expected circumstances
(economic and industry)?
· Does the current stock price fairly represent Gilbert’s value in the market?
· What is the “real” value of Gilbert’s stock? And how should it be determined (methods, process)?
· Other issues ….
c. Approach
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Identify the appropriate analytical techniques (dividend valuation model) to evaluate Gilbert’s value in
the market; use a price-earnings approach to supplement the dividend model results; and use selected
ratio comparative analysis to fairly position Gilbert against its competitors; and specifically answer the
case questions.
d. Case-specific Questions
D0
Current dividend (given) 1.20
=
D1 (D0 *
Future dividends 1.38 X 0.9091 1.25
= 1.15)
(D1 *
D2 = 1.59 X 0.8264 1.31
1.15)
(D2 *
D3 = 1.83 X 0.7513 1.37
1.15)
Total 3.94
P3 = D4
Ke - g
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D4 = D3 (1 + g)
= 1.935
at 10%
Est of P0 $36.34
total is as high as
Add PV of dividends = 3.94
$40.37
Total $40.27
Conclusion: Because the stock is selling in the market for 35 1/4th, it appears to be undervalued.
2. Gilbert’s P/E ratio is currently is the second lowest of all firms in the industry. However, based on the
financial information provided in Figure 1 this does not appear to be appropriate, given that Gilbert
currently has the highest growth rate of EPS and growth is expected to accelerate to 15%
(supernormal) growth over the next three years.
( This is financial ratio a nalysis )It also has the second highest return on stockholder’s equity, and the
firm leading this category has a very high debt ratio (resulting in a relatively smaller proportion of equity
over which to spread the earnings – it is possible to generate a high return on equity using debt, but still
have relatively low profitability, as Reliance has in this case as indicated by its lowest return on total
assets ratio in the industry).
In evaluation debt utilization as a separate issue, Gilbert once again looks attractive with a debt to total
asset ratio of 33%, with Standard Auto being the only firm with a better (lower) ratio.
Market Values
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Evaluation of market to book values and market to replacement values will provide additional insight
about Gilbert’s financial position in the industry. Although pro forma market value to book value
($40.27/$16.40 = 2.46) is high compared to others (1.40 to .92), this is not an especially meaningful
value, because book value is based on historical cost. A more meaningful value is market to
replacement, in which Gilbert is much more conservative ($40.27/$43.50 = .93), and is comparable to
Standard Auto ($24.25/$26.00 = .93).
Dividends are another area where Gilbert is excelling, second only to Standard in dividend yields.
Finally, how would Gilbert’s pro forma P/E ratio compare with the industry? One must first calculate the
EPS, since it is not provided.
16.8 = $35.25/EPS
Now, calculate the pro forma P/E ratio given the estimate of the intrinsic stock price of $40.27 in the
earlier analysis.
P/Epf = $40.27/$2.098 = 19.2, still within the appropriate range for the industry (industry average is now
18.9).
In summary, Gilbert appears to be undervalued compared to its competition, considering all of the
findings previously reported.
Based on the answers to Questions 1 and 2, Gilbert Enterprises appears to be undervalued, and Roth
should seriously consider recommending the firm repurchase part of its shares in the marketplace.
However, there is reason to be cautious:
· ( Be creative here; you get credit for thinking outside the box (but not too far out) )Markets are efficient
in their pricing of securities (Efficient Market Hypothesis), and there may be some information that we
are not aware of that justifies Gilbert’s lower valuation.
· Secondly, even if the stock is undervalued in the marketplace, management must make certain that
this is the best use of its limited investment funds (examine alternative uses).
e. Other options?
Although there are no indications in the case that Gilbert has alternatives to this repurchase plan, it
should exhaust the possibilities of purchasing another firm or firms in the industry that might provide
positive synergies, add sales in areas that Gilbert is lacking, cover geographic areas currently
underserved, or focus on a firm that provides a good “fit” with its state-of-the-art inventory management
systems.
As an alternative, it could significantly reduce the number of shares it in considering (up to one million
shares), and use the remainder for other investments.
f. Prediction
I believe that Albert Roth will recommend the repurchase, and that it will be successful. After all, Roth in
an investment banker and is there to serve his client while earning profits from additional revenue for
his firm – Baker, Green and Roth.
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