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STREETSMART GUIDE TO VALUING A STOCK
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Debt Outstanding. The third-quarter balance sheet for WRE shows $265 million in notes payable, $87.2 million of mortgage notes payable, and $53.7 million in line of credit payable. We assume that all three of these categories either are payable over the long term or will be converted to long-term debt by WRE. Our entry for debt outstanding was $405.9 million. Preferred Stock Outstanding. WRE had no preferred stock outstanding, 0. Preferred Stock Yield. 0. Risk-Free Rate. We used the 10-year Treasury yield on December 20, 2002 of 3.96 percent. Bond Spread to Treasury. Interest expense of $27.071 million was about 7.54 percent on the debt outstanding in 2001. The 10-term Treasury rate averaged close to 5 percent during 2001, so we estimate that WRE s Bond Spread to Treasury was about 2.5 percent, which was our entry. Beta. In accordance with our previous discussion relating to beta for an REIT, our beta entry was 0.80 for WRE. Equity Risk Premium. We used 3 percent for this input for our valuation examples.
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Washington REIT Valuation Baseline Scenario: 5.5-Percent Growth Rate, 3.96-Percent Interest Rate, Value $24.04
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The results of the baseline valuation are shown in ValuePro general input screen (Exhibit 8-27), which shows WRE to have a WACC of 6.39 percent. In this scenario, WRE s stock has an intrinsic value of $24.04 6 percent lower than its closing price on December 20th of $25.55.
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Washington REIT Valuation Higher Interest Rate Scenario: 5.5-Percent Growth Rate, 0.25 Percent per Year Increasing Interest Rate, Value $16.85
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We felt comfortable with the growth rate and NOPMs of Washington REIT. What concerned us most about this scenario was the effect of increasing interest rates on WRE s stock price. At the time of this valuation, interest rates were at historically low levels. Absent a general and prolonged deflation, which occurred in Japan during the 1990s
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Valuing a Stock Putting It All Together
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EXHIBIT 8-27
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Washington REIT General Input Screen Baseline Scenario
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through 2000, it was our belief that interest rates would rise significantly from their current levels. Let s assume that long-term interest rates increase one-quarter percent per year over the next five years. How does this interest rate movement affect WRE s intrinsic stock value We use the custom input screen to handle this type of what-if scenario. In the WACC column of the custom input screen (Exhibit 8-28), we increased the WACC one-quarter percent per year over a 5-year period from 6.39 percent in year 1, to 6.64 percent in year 2, . . . to 7.64 percent in years 6 to 10 a total interest rate increase of 1.25 percent. Keeping all other inputs constant, displayed at the top of the custom input screen is the new intrinsic value $16.85. The cash flows associated with this scenario are shown in the custom pro forma screen, Exhibit 8-29.
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Washington REIT Stock Buy Sell Hold
In valuing Washington REIT, we looked at two scenarios. The baseline scenario had a 5.5-percent growth rate, a 10-year Treasury rate of 3.96 percent, and a WACC of 6.39 percent, and resulted in an intrinsic value of $24.04. The second scenario assumed all of the inputs of the baseline scenario, and an increase in interest rates of one-quarter percent per year over a 5-year period. WRE s weighted average cost of capital
STREETSMART GUIDE TO VALUING A STOCK
EXHIBIT 8-28
Washington REIT Custom Input Screen Higher Rate Scenario
increased from 6.39 percent in year 1 to 7.64 percent in years 6 to 10. WRE s intrinsic stock value slipped to $16.85 percent. A relatively small movement in interest rates dropped WRE s intrinsic stock price $7.43, or 30 percent. Washington REIT is a very well-run real estate investment trust with steady NOPMs and decent growth. However, it was our belief that the downside risk of the stock was greater than the upside potential. Although it was not greatly overpriced at $25.55, at this level at the time of the valuation, we viewed Washington REIT as a weak sell.
EXHIBIT 8-29
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