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BUY RECOMMENDATION Firm: Bear Stearns Companies, Inc. Sector: Financial Services (Investment Bank) Anne Rife Cox Endowment Fund Spring 2003 Past 5-Year Performance Analyst: Cameron W. George Contact at [email protected] NYSE Ticker: BSC Moody’s Debt Rating: A2↑ Analyst: Pierce L. Lowrey Contact at [email protected] This Bear Never Hibernates Summary Findings and Other Highlights I. Diversification: We inherited the financial services sector to find that the previous class had placed bets on certain sub-sectors. We would like to refine the sector as we make our own bets, so we have sold off portions of the sector and replaced them with the intention of diversifying our holdings. As part of the process, we need to buy an investment bank to enhance our diversification strategy. Relevant Performance Data (On April 2, 2003) Market Price: Shares Outstanding: Market Capitalization: 52-Week Low: 52-Week High: Price/Earnings: Industry Price/Earnings: Price/Book: Industry Price/Book: Price/Sales: Industry Price/Sales: EPS Estimate: Beta: Industry Beta: $69.48 96.2 M $6.68 B $50.50 $70.00 9.37 15.70 1.16 2.16 1.38 1.84 $6.33 1.47 1.75 Corporate Profile “The Bear Stearns Companies Inc. is an investment banking, securities and derivatives trading, clearance and brokerage firm serving corporations, governments, institutional and individual investors worldwide. The Company is a holding firm that operates through its subsidiaries, principally Bear, Stearns & Co. Inc., Bear Stearns Securities Corp. (BSSC), Bear Stearns International Limited and Bear Stearns Bank plc. The Company is primarily engaged in business as a securities broker/dealer operating in three principal segments: capital markets, global clearing services and wealth management. Certain capital markets products are distributed by the wealth management and global clearing services distribution networks with the related revenues of such intersegment services allocated to the respective segments.” Graph Source: Yahoo! Finance Performance Data Source: Multex Profile Source: Yahoo! Finance II. Industry scandals: Many recent scandals involving investment banks have left us with few viable options for a solid growth opportunity. We eschewed banks that had been numbed by fines and disciplinary actions, and focused on Bear Stearns, the 223rd largest firm of the Fortune 500. III. Higher debt rating: Fitch, among other agencies, recently upgraded Bear Stearns’ debt rating to A+, citing that “liquidity, funding, and capital are prudently managed.” IV. High bear market performance: Bear Stearns has performed exceptionally well during the economic downturn, increasing net income by 42% in 2002 and outstripping all of its major competitors in capital gains over the same time period. V. Private client strategy: In an effort to bolster its private client group, Bear Stearns very recently hired one of the industry’s most successful brokers to its New York office. Richard Saperstein brings with him more than $5.5 billion in assets under management and rich opportunities for Bear Stearns to expand its access to high-net-worth clients. VI. Valuation: We used a flow-to-equity method because the cash flows from Bear Stearns’ significant debt activities have an unjust and inaccurate impact on the firm’s free cash flows. Additionally, free cash flow valuation is difficult because of an uncertain cost of debt. Our bet: We expect M&A and equity issuance activities to pick up in the near future as companies seek growth opportunities through mergers and acquisitions and rebalance Key Competitors and Approximate Market Caps Closest competitor: Merrill Lynch ($35 B) Others: Morgan Stanley ($46 B), Goldman Sachs ($34 B), CSFB ($21 B) BSC Performance Relative to Merrill Lynch, Dow, NASDAQ, and S&P 500 Orientation to the Industry 250 200 150 100 50 Br ot he rs rg (U BS Cr ed A it G ) Su iss eG N ro om up ur aH ol di ng s Be ar St ea rn s ti) (C i U BS W ar bu Le hm an Ba rn ey Sm ith G ol dm an Sa c hs lL yn ch Sa lo m on M er ril St an le y 0 M or ga n Market Cap ($ billions) Top Investment Banks by Market Capitalization Orientation to the Firm Bear Stearns' Composition of Revenues 2002 Other Income 3% Commissions 16% Interest and Dividends 32% Investment Banking 12% Principal Transactions 37% Origin of Bear Stearns Partners Joseph Bear, Robert Stearns, and Harold Mayer founded bear Stearns in 1923 with $500,000 in capital. The Company survived the stock market crash of the late-1920s by promoting government bonds, and exhibited strong management by weathering the storm without employee layoffs. An international department opened in 1948, and over the next few years, branch offices popped up around the globe: Geneva (1963), San Francisco (1965), Paris (1967), and Los Angeles (1968). Formerly of Salomon Brothers, Cy Lewis headed the company during the 1950s-1960s, and later fashioned himself into a colorful Wall Street legend as Bear Stearns’ chairman. During Lewis’ tenure, Jerome Kohlberg, Henry Kravis, and George Roberts left the Company to start a firm that would become leveraged buyout powerhouse KKR. Alan Greenberg replaced Lewis in 1978, and over the next three years he created the government and mortgage-backed securities divisions. In 1984, he formed Bear Stearns Asset Management and Custodial Trust. The next year Greenberg took Bear Stearns public as The Bear Stearns Companies, Inc. and thereafter brought investment banking under the corporate roof—by 1991 Bear Stearns had become the leading investment underwriter in the Latin American market. Concurrently, Greenberg set up Bear Stearns Securities Corporation to handle new clearing business. Bear Stearns was slow to recover from the 1994 bond market crash, since its fiscal year does not align with the calendar year and decreased earnings from the crash were not reported until mid-1995. The securities industry is so competitive that when employees’ bonuses took a hit from reduced revenues, several senior bond executives left for other firms. In 1997, Bear Stearns teamed up with National Mortgage Bank of Greece to bring mortgage- and assetbacked securitization to Greece. Also, it opened a branch office in Ireland to gain further access to the European market. The year also marked the beginning of Bear Stearns’ investment in high-tech, communications, and media businesses. Although Bear Stearns was not involved in any major accounting scandals or other fraud during the late 1990s and early 2000s, some legal “ghosts from the past” cropped up in 1998 relating to proceedings initiated in the 1980s. Three noteworthy jury awards and settlements reached approximately $200 million in total. Current Status of Bear Stearns James Cayne is now Chairman and CEO following Greenberg’s unofficial retirement in 2001. Greenberg remains active in the company as a director and Chairman of the Executive Committee. Bear Stearns operates three divisions: (1) Capital Markets, (2) Global Clearing Services, and (3) Wealth Management. (1) Capital Markets, by far the largest component of the Bear Stearns brand, serves institutional clients and offers fixed income, equities, and investment and merchant banking services. (2) Global Clearing Services offers prime broker and broker-dealer clearing services, such as margin lending and securities borrowing and is one of the largest clearing operations on Wall Street. (3) Wealth Management represents Bear Stearns’ private client group and asset management business and focuses on high-net worth clientele. In total, the asset management subsidiary manages more than $20 billion in Sources: Hoovers, Bear Stearns assets. Top 10 Investment Banks by Sales Morgan Stanley Merrill Lynch Goldman Sachs Salomon Smith Barney Lehman Brothers UBS Warburg Credit Suisse First Boston Nomura Holdings Bear Stearns UBS Paine Webber Industry Outlook Political volatility, in addition to the timing of economic recovery, remains a key force on the future of the financial services industry. Questions remain about accounting scandals and corporate fraud, and only time will tell whether enough political measures have been taken to alleviate these concerns. The judicial system is expected to have an impact as risk of litigation should dissuade companies from engaging in suspicious financial transactions and courts may address the conflict of interest between research and investment banking. In the short-term, we look for additional problems among financial services as these new rules take effect, but we expect the long-term perspective to improve as the rules are tested and the companies learn how to apply them appropriately. In an industry where reputation is a firm’s biggest asset, we believe Bear Stearns—unlike many of its competitors who have received more than their share of negative headlines—has managed to shield itself from costly scandals and will likely emerge relatively untarnished. Towards the end of 2003, mergers and acquisitions (M&A) and equity issuance activities should pick up if corporate profits continue to recover. In a sustained period of equity market stability, we believe corporations will need to rebalance their capital structures following recent record levels of debt issuance. Further, we expect that Bear Stearns and other firms within the industry will receive the benefits of an upturn in capital markets in their specialist and wealth management units as more high-net worth investors return to professional brokerage from self-managed accounts. Bear Stearns recently hired one of the most successful brokers on Wall Street, Richard Saperstein, who brings with more than $5.5 billion in assets under management and tremendous opportunities for the company to expand its access to wealthy individuals. Bear Stearns has been actively seeking ways to improve its private client services, and Richard Saperstein may very well be the key. Across the industry, many investment banks are reporting that M&A assignments have become more strategic as compared to the “out-of-the-box” merger mania that defined the irrational exuberance of the 1990s. For example, instead of an acquirer targeting a business outside its own core competencies, companies are reexamining their motivations for merger activity to find more practical corporate pairings since those “out-of-the-box” transactions typically resulted in higher historical failure rates. Ultimately mergers completed in the late 1990s that were based on doubtful synergies and overzealous senior management have brought about detrimental effects on capital markets. We anticipate future prosperity within the financial services industry as M&A activity continues and picks up in the shortterm. Despite these potential increases in M&A and equity issuance activities, we acknowledge that a significant number of uncertainties grip the world and the economy. Bear Stearns has still positioned itself to weather the lingering storm—should traditional investment banking activities not immediately increase—through its institutional activity in the areas of equity derivatives, convertible arbitrage, and interest rate and credit products. Sources: Yahoo! Finance, Hoovers, Grant Thornton, LLC Comparative Analysis: Bear Stearns in a Greater Context Bear Stearns’ Performance Relative to S&P 500: Bear Stearns has clearly outperformed the Standard & Poor’s 500 for the last year despite well-known skepticism in the broad equity market. With uncertainties, such as corporate scandals, deregulation within the banking industry, war in Iraq, and global crises, weighing on investors, Bear Stearns has still managed to increase its net income over the past year by 42%. We believe Bear Stearns will benefit greatly if the economy stabilizes in the next year, since characteristically banks have significant operating leverage and attract positive early cycle performance in an economic upturn. Even if the economic rebound eludes investors, we expect that Bear Stearns has still positioned itself appropriately within the industry to remain profitable despite ongoing concerns of war, e.g., the timeliness and outcome of war and the effect on M&A and equity issuance activities, and other relevant issues because of the Company’s positive performance over the past, unstable year. Bear Stearns’ Performance Relative to Top Competitors and Industry: Exhibit 1: Competitive Landscape P/Earnings ROA ROE Net Profit Margin P/Sales ST EPS Growth LT EPS Growth PEG Source: Multex Investor Services, Hoovers, Yahoo! Finance BSC 9.37 .5% 17.1% 13.87% GS 16.18 .6% 11.9% 9.69% LEH 17.02 .4% 11.9% 6.86% MER 13.79 .6% 11.2% 8.89% Industry 15.7 .6% 11.3% 8.48% .98 60.1% 1.47 13.0% .90 (8.8%) 1.25 361.4% 1.91 (7.7%) 11.9% (9.8%) (14.4%) (21.8%) (11.8%) 1.10 1.26 1.23 1.18 1.87 Competitive Landscape As seen in Exhibit 1 on the previous page, Bear Stearns has a lower price/earnings ratio than its competitors and other companies within the industry; the low price/earnings metric means Bear Stearns’ investors pay relatively less for earnings than do investors in competing companies. While this lowerthan-average price/earnings figure might represent lower expected future growth, we believe that Bear Stearns defies a low-growth stereotype in its expected short-/long-term earnings per share (EPS) growth, return on equity (ROE), and return on assets (ROA) numbers. With the exception of Merrill Lynch in the 12-month EPS growth, analysts predict Bear Stearns will reward investors relatively better than will its competitors. As seen in the following graphs, Bear Stearns is clearly outperforming its rivals and has successfully weathered the current economic downturn. Bear Stearns vs. Lehman Brothers (LEH) and the Dow Jones 30 Bear Stearns vs. Morgan Stanley (MWD) and the Dow Jones 30 Bear Stearns vs. Merrill Lynch (MER) and the Dow Jones 30 Bear Stearns vs. Goldman Sachs (GS) and the Dow Jones 30 Bear Stearns vs. Credit Suisse Group (CSR) and the Dow Jones 30 COMPARABLE COMPANY VALUATION ANALYSIS (On April 2, 2003) Financial Data for Valuation Industry Bear Stearns Firm Name BSC Ticker 96,186,960 Shares Outstanding $69.48 Price 15.7 9.37 Price/Earnings 2.16 1.16 Price/Book 1.84 1.38 Price/Sales $842,739,000 Net Income $7.18 Earnings Per Share $6,890,816,000 Sales $6,683,069,981 Market Capitalization $6,382,083,000 Book Value of Equity $66.35 Book Value/Share 1.75 1.47 Beta $0.68 Dividends Paid 1.51% 1.01% Dividend Yield 22.03% 8.42% Payout Ratio $70.00 52-Week High Price $50.50 52-Week Low Price Theoretical Value based on Comparable Industry Ratios Key Valuation Ratios ACF Value based on industry Price/Earnings ratio ACF Value based on industry Price/Sales ratio ACF Value based on industry Price/Book ratio Merrill Lynch MER 876,157,083 $38.26 13.79 1.4 1.21 $2,513,000,000 $2.69 $28,253,000,000 $33,521,769,996 $22,875,000,000 $26.11 1.55 $0.64 1.77% 22.29% $55.20 $28.21 Firm Values (Equity) $13,231,002,300 $12,679,101,440 $13,785,299,280 $12,955,051,870 Averages Financial Data of Closely Competing Firms Morgan Stanley Goldman Sachs MWD GS 1,039,046,651 453,824,586 $41.80 $72.40 14.53 16.18 1.98 1.75 1.37 1.57 $2,988,000,000 $2,114,000,000 $2.75 $4.34 $32,450,000,000 $22,854,000,000 $43,432,150,012 $32,856,900,026 $21,885,000,000 $19,003,000,000 $21.06 $41.87 2.11 1.83 $0.92 $0.48 2.30% 0.69% 32.92% 10.65% $57.29 $89.45 $28.80 $58.57 Firm Name Ticker Shares Outstanding Price Price/Earnings Price/Book Price/Sales Net Income Earnings Per Share Sales Market Capitalization Book Value of Equity Book Value/Share Beta Dividends Paid Dividend Yield Payout Ratio 52-Week High Price 52-Week Low Price Stock Prices $85.51 $81.95 $89.10 $85.52 Note: Net income, sales, market capitalization, and shares outstanding figures approximated for consistency among firms. Metrics from trailing twelve month periods, except Price/Book. Price/Book from most recent quarter. Source of information: Multex Investor Services Key Explanations: Although Bear Stearns does, in fact, pay a dividend, we do not believe that a valuation based on discounting dividends would accurately reflect Bear Stearns' intrinsic price. Notice that Bear Stearns' payout ratio is very small in comparison to the payouts of its closest competitors and the industry in general--therefore a dividend-related discouont model would naturally price Bear Stearns excessively low. Instead, we have presented this comparable company valuation analysis which shows Bear Stearns as it compares to its three closest competitors. We have also presented a discounted cash flow analysis using the flow-to-equity method, which appears in the following pages. We believe the intrinsic value of Bear Stearns to be within the range of prices depicted in both the comparable company and discounted cash flow analyses. DETERMINATION OF FLOW-TO-EQUITY CASH FLOWS (Note: All numbers in U.S. dollars and to correct decimal place as presented, unless otherwise indicated.) Finish here: Net Income Non-Cash Items Included in Net Income: Depreciation/Depletion Deferred Income Taxes Employee Stock Compensation Plans Other Changes in Operating Assets and Liabilities: Cash, Clearing Organizations/Federal Regulations Securities Purchased Under Resell Agreements Securities Borrowed Receivables from Customers Receivables from Broker/Dealers, et al Financial Instruments Owned Other Assets Securities Sold Under Repurchase Agreements Payables to Customers Payables to Broker/Dealers, et al Financial Instruments Sold (Not yet purchased) Accrued Employee Compensation/Benefits Other Liabilities and Accrued Expenses OPERATING CASH FLOWS -Capital Expenditures FLOW-TO-EQUITY CASH FLOWS 2001 Actual 624,965,000 2002 Actual 878,345,000 2003 Forecast 1,116,030,358 2004 Forecast 1,172,947,906 2005 Forecast 1,232,768,249 2006 Forecast 1,295,639,430 2007 Forecast 1,361,717,041 208,822,000 -232,916,000 355,612,000 16,423,000 161,879,000 -24,374,000 533,240,000 16,043,000 185,350,500 -128,645,000 533,240,000 16,043,000 185,350,500 -128,645,000 533,240,000 16,043,000 185,350,500 -128,645,000 533,240,000 16,043,000 185,350,500 -128,645,000 533,240,000 16,043,000 185,350,500 -128,645,000 533,240,000 16,043,000 -5,514,441,000 -6,243,253,000 9,848,739,000 -243,724,000 -2,038,030,000 -4,424,247,000 584,722,000 -1,552,833,000 6,804,906,000 3,431,849,000 5,743,264,000 -191,910,000 -105,665,000 7,072,283,000 -185,300,000 6,886,983,000 2,187,535,000 5,237,038,000 -1,205,175,000 -546,240,000 1,469,704,000 -5,130,001,000 -217,640,000 -5,665,881,000 223,888,000 673,646,000 -327,767,000 -120,267,000 487,722,000 -1,368,305,000 -126,620,000 -1,494,925,000 -1,970,450,000 5,665,881,000 -1,205,175,000 -394,982,000 -284,163,000 -5,884,111,147 183,541,000 -5,665,881,000 3,656,783,000 2,052,747,500 2,707,748,500 -156,088,500 191,028,500 618,897,711 -126,620,000 492,277,711 -1,970,450,000 5,665,881,000 -1,205,175,000 -394,982,000 -284,163,000 -5,884,111,147 183,541,000 -5,665,881,000 3,656,783,000 2,052,747,500 2,707,748,500 -156,088,500 191,028,500 675,815,259 -126,620,000 549,195,259 -1,970,450,000 5,665,881,000 -1,205,175,000 -394,982,000 -284,163,000 -5,884,111,147 183,541,000 -5,665,881,000 3,656,783,000 2,052,747,500 2,707,748,500 -156,088,500 191,028,500 735,635,602 -126,620,000 609,015,602 -1,970,450,000 5,665,881,000 -1,205,175,000 -394,982,000 -284,163,000 -5,884,111,147 183,541,000 -5,665,881,000 3,656,783,000 2,052,747,500 2,707,748,500 -156,088,500 191,028,500 798,506,783 -126,620,000 671,886,783 -1,970,450,000 5,665,881,000 -1,205,175,000 -394,982,000 -284,163,000 -5,884,111,147 183,541,000 -5,665,881,000 3,656,783,000 2,052,747,500 2,707,748,500 -156,088,500 191,028,500 864,584,394 -126,620,000 737,964,394 2004 Forecast 7,611,602,244 2,740,176,808 4,871,425,436 1,217,856,359 3,653,569,077 1,902,900,561 1,750,668,516 577,720,610 1,172,947,906 2005 Forecast 7,999,793,959 2,879,925,825 5,119,868,134 1,279,967,033 3,839,901,100 1,999,948,490 1,839,952,611 607,184,361 1,232,768,249 2006 Forecast 8,407,783,451 3,026,802,042 5,380,981,409 1,345,245,352 4,035,736,056 2,101,945,863 1,933,790,194 638,150,764 1,295,639,430 2007 Forecast 8,836,580,407 3,181,168,946 5,655,411,460 1,413,852,865 4,241,558,595 2,209,145,102 2,032,413,494 670,696,453 1,361,717,041 DETERMINATION OF NET INCOME Start here: Revenues Cost of Revenues Gross profit Operating Expenses EBIT Interest Expense Income before taxes Income tax expense NET INCOME 2001 Actual 8,701,033,000 2,865,464,000 5,835,569,000 1,107,127,000 4,728,442,000 3,793,998,000 934,444,000 309,479,000 624,965,000 Sources: Yahoo! Finance, Multex Investor Services, Bear Stearns 2002 Actual 6,890,816,000 2,705,463,000 4,185,353,000 1,111,810,000 3,073,543,000 1,762,580,000 1,310,963,000 432,618,000 878,345,000 2003 Forecast 7,242,247,616 2,607,209,142 4,635,038,474 1,158,759,619 3,476,278,856 1,810,561,904 1,665,716,952 549,686,594 1,116,030,358 Key Assumptions Necessary to Determine Net Income "Revenue" includes fees from commissions, principal transactions, investment banking, interest and dividends, and other activities. "Revenue" will grow by 5.1% every year through 2007. "Cost of Revenues" includes employee compensation and benefits, floor brokerage, and exchange and clearance fees. "Cost of Revenues" is assumed to be 36% of Revenues. Tax rate is calculated to be 33%. "Operating Expenses" include communications and technology, occupancy, advertising and market development, professional fees, and other expenses. "Operating Expenses" will be 16% of Revenues. Key Assumptions Necessary to Determine Flow-to-Equity Cash Flows for Years 2003 Through 2007 "Depreciation/Depletion" is an average of the 2001 and 2002 levels. "Deferred Income Taxes" is an average of the 2001 and 2002 levels. "Employee Stock Compensation Plans" kept constant at 2002 level until 2007. "Other" kept constant at 2002 level until 2007. "Cash, Clearing Organizations/Federal Regulations" refers to cash and securities deposited with clearing organizations or segregated in compliance with federal regulations, and is estimated to be an average of the 2000, 2001, and 2002 levels because of recent volatility. "Securities Purchased Under Resell Agreements" is estimated to decrease by the same amount by which "Securities Sold Under Repurchase Agreements" decreased in 2002. We noticed that these accounts fluctuated by a similar amount in 2002, and we expect this trend to continue through 2007. "Securities Borrowed" kept constant at 2002 level until 2007. "Receivables from Customers" is an average of the 2001 and 2002 levels. "Receivables from Broker/Dealer and Others" is an average of the 2001 and 2002 levels. "Financial Instruments Owned" is expected to increase by 14.7% in 2003 and remain there until 2007, based on the geometric mean return of the 2000, 2001, and 2002 levels. "Other Assets" is an average of the 2001 and 2002 levels. "Securities Sold Under Repurchase Agreements" kept constant at 2002 level until 2007. "Payables to Customers" is an average of the 2000, 2001, and 2002 levels because of recent volatility. "Payables to Broker/Dealer and Others" is an average of the 2001 and 2002 levels. "Financial Instruments Sold (Not yet purchased)" is an average of the 2001 and 2002 levels. "Accrued Employee Compensation/Benefits" is an average of the 2001 and 2002 levels. "Other Liabilities and Accrued Expenses" is an average of the 2001 and 2002 levels. "Capital Expenditures" kept constant at 2002 level until 2007, then we expect it will increase according to the terminal growth rate. DISCOUNTED CASH FLOW (DCF) ANALYSIS: FLOW-TO-EQUITY METHOD Key Assumptions: $69.48 96,186,960 -$1,494,925,000 5.10% 3.00% $23,681,399,000 1.47 A2 6.50% 0.78 0.22 33% 1.5% 0.2 3.90% 3.47% Market stock price on April 2, 2003 Common shares outstanding Flow-to-equity cash flows at Time 0 Forecasted 5 year sales growth rate Terminal growth rate Long-term liabilities (book=market) Equity Beta Moody's Bond Rating Market Risk Premium =Wd =Ws Tax rate Risk-free rate Debt Beta Return on 10-Year Treasury Bill Weighted average cost of capital Unnecessary in the flow-to-equity analysis. (FYI only) Unnecessary in the flow-to-equity analysis. (FYI only) Unnecessary in the flow-to-equity analysis. (FYI only) Unnecessary in the flow-to-equity analysis. (FYI only) Unnecessary in the flow-to-equity analysis. (FYI only) Unnecessary in the flow-to-equity analysis. (FYI only) Information Contained Herein Unnecessary in the Flow-to-Equity Analysis and Presented for Your Information Only. Equity financing= $6,683,069,981 Current market capitalization. Debt financing= $23,681,399,000 Book value of long-term debt from 2002 balance sheet. 0.78 =Wd 0.22 =Ws Weight of debt financing in corporate capital structure. Weight of equity financing in corporate capital structure. 1.98% =Kd Cost of debt financing. Derived from CAPM-based cost of debt equation, using debt beta of .20. 11.06% =Ks Cost of equity financing. Derived from Capital Asset Pricing Model. Discount PV of flow-to-equity cash flows by this cost of equity. 2002 Time CFs 2003 -$1,494,925,000 $492,277,711 2004 2005 2006 $549,195,259 $609,015,602 $671,886,783 Terminal Value 2007 $737,964,394 $9,436,416,211 CFs Disregard $492,277,711 $549,195,259 $609,015,602 $671,886,783 $10,174,380,605 PVs Disregard $443,273,793 $445,297,797 $444,645,672 $441,716,510 $6,023,062,885 Present value of flow-to-equity cash flows, discounted by the cost of equity = Value of firm's equity $7,797,996,657 =Value of firm (equity only) Find the value of equity on a per-share basis: Sensitivity Analysis With Respect to Various Costs of Equity $81.07 =Intrinsic value of BSC stock Ks of 10.95% $82.18 Ks of 11.00% $81.65 Ks of 11.05% $81.12 Ks of 11.10% $80.60 Key Explanations: We used a flow-to-equity valuation method instead of a free cash flow method because cash flows from the firm's debt activities, such as interest income and interest expense, have a significant and unjust impact on the free cash flow calculation. We believe that a flow-to-equity method presents the most unbiased valuation of the firm because it excludes from consideration the fact that financial services companies are often debt-laden. Accordingly, debt aspects are not included in the valuation model. However, in determining the WACC--although the flow-to-equity method does not discount by the WACC--we made these choices: We calculated the cost of debt to be 1.98% based on a CAPM-based equation that considers the risk-free rate, the return on the 10-Year Treasury Bill, and a debt beta. We believe this to be a more accurate method than comparing the yields-to-maturity (YTMs) on BSC's most recent debt issues. Reason: Investment banks like BSC issues a variety of debt instruments, and the YTMs can vary among them. Since we cannot know specifically for what purpose all the bonds were issued, we have calculated the cost of debt based on prevailing market rates and a debt beta that reasonably describes the riskiness of BSC's A2-rated long-term bonds. We used the book value of long-term debt since BSC's credit rating is high (recently upgraded) and the bonds are non-callable. We expect BSC to continue as a going concern, so BSC's long-term debt obligation should be fairly close to the book value of the debt. Bear Stearns in the Headlines “Bear Stearns Lures One of Industry’s Top Brokers” Source: Dow Jones Business News (4/6/03) Synopsis: Bear Stearns hires superstar broker Richard Saperstein, who brings $5.5 billion in assets under management and the opportunity for the Company to expand its private client group with new access to high-net-worth clients. “Fitch Revises Bear Stearns’ Outlook Up, to Stable” Source: Reuters (3/8/03) Synopsis: Citing prudently managed liquidity, funding, and capital resources, Fitch upgraded Bear Stearns’ debt rating to A+. “Bear Goes Bull” Source: Motley Fool (3/19/03) Synopsis: Bear Stearns has outperformed its competitors during the bear market through huge bond trading and underwriting operations. Growth in fixed income and mortgage-backed securitization have helped fuel Bear Stearns’ profits. “Record Bond Results Boost Bear Stearns” Source: Reuters (3/19/03) Synopsis: Bear Stearns posted its fifth straight quarterly profit increase and has outperformed peers such as Goldman Sachs and Morgan Stanley as its mortgage-backed business has benefited from low U.S. interest rates. Executives were upbeat on the future of the mortgage business. “Bear Stearns Wallops Street with 52 Percent Profit Jump” Source: CBS MarketWatch (3/19/03) Synopsis: Bear Stearns blew out analysts' expectations by announcing a 52% jump in net income to $274 million on strong fixed-income trading results. “Bear Stearns Comfortable with Staffing Levels” Source: Dow Jones Business News (3/19/03) Synopsis: Bear Stearns is "comfortable" with its staffing level and has no plans for further layoffs, said Chief Financial Officer Sam Molinaro. The Company’s staffing level rose 1.6% to 10,506 at the end of February compared with a year earlier. Bear Stearns also plans to add more brokers that cater to wealthy investors. “Bear Stearns Braves Downturn, Opens UK Private Bank” Source: Reuters (3/17/03) Synopsis: Bear Stearns has set up its first European private bank in London, bucking the retrenchment going on at many of its rivals hit by tumbling equity markets.