As a new junior analyst for a large brokerage firm, you are anxious to demonstrate theskills you learned in college and prove that you are worth your attractive salary. Your first assignment is to analyze the stock of General Electric Corporation. Your boss recommends determining prices based on both the discounted free cash flow valuation method and the comparable P/E ratio method. You are a little concerned about your boss's recommendation because your finance professor has told you these two valuation methods can result in widely differing estimates when applied to real data. You are really hopingthe two methods will reach similar prices.
1. Go to Yahoo! Finance (https://finance.yahoo.com) and enter the symbol for GeneralElectric (GE). From the main page for GE, gather the following information andenter it into a spreadsheet:
a. The current stock price (last trade) at the top of the page.
b. The EPS (ttm).
2. Click on "Key Statistics" at the left side of the page. From the Key Statistics page, find the number of shares of stock outstanding and enter it in the same spreadsheet.
3. Click on "Analyst Estimates" at the left side of the page. On the Analyst Estimates page, find the expected growth rate for the next five years and enter it into yourspreadsheet. It will be near the very bottom of the page.
4. Click on "Competitors" at the left side of the page. The industry average P/E ratiois in the far right column, marked "Industry." Copy it into your spreadsheet.
5. Click on "Income Statement" near the bottom of the menu on the left. Copy andpaste the entire three years' worth of income statements into a new worksheet inyour existing Excel file. Repeat this process for both the balance sheet and the cashflow statement for General Electric. Keep all of the different statements in the same Excel worksheet.
6. To determine the stock value based on the discounted free cash flow method:a. Forecast the free cash flows using the historic data from the financialstatements downloaded from Yahoo! Finance to compute the three-yearaverage of the following ratios:i. EBIT/salesii. Tax rate (income tax expense/income before tax)iii. Property plant and equipment/salesiv. Depreciation/property plant and equipmentv. Net working capital/sales
b. Create an empty timeline for the next five years.
c. Forecast future sales based on the most recent year's total revenue growing atthe five-year growth rate from Yahoo! Finance for the first five years.
d. Use the average ratios computed in part (a) to forecast EBIT, property, plant andequipment, depreciation, and net working capital for the next five years.
e. Forecast the free cash flow for the next five years using Eq. 10.2.
f. Determine the horizon enterprise value for year 5 using Eq. 10.6 and a longrungrowth rate of 4% and a cost of capital for GE of 11%.
g. Determine the enterprise value of the firm as the present value of the free cashflows.
h. Determine the stock price using Eq. 10.4. Note that your enterprise value is in$ thousands and the number of shares outstanding is in billions.
7. To calculate an estimate of GE's price based on a comparable P/E ratio, multiplythe industry average P/E ratio by GE's EPS.
8. Cmpare the stock prices produced by the two methods to the actual stock price.What recommendations can you make as to whether clients should buy or sellGeneral Electric's stock based on your price estimates?
9. Explain to your boss why the estimates from the two valuation methods differ.Specifically address the assumptions implicit in the models themselves as well asthe assumptions you made in preparing your analysis. Why do these estimatesdiffer from the actual stock price of GE?