Application Assignment: Stock Valuation
As a manager, it is important to understand how decisions can be analyzed in terms of alternative courses of action and their likely impact on a firm's value. Thus, it is necessary to know how stock prices can be estimated before attempting to measure how a particular decision might affect a firm's market value.
Defend your choice of model, and explain why it is appropriate to use for your company's stock. Be sure to explain how you arrived at any assumptions regarding values used in the model. Determine whether your company appears to be correctly valued, overvalued, or undervalued based on your company's stock current price and model result. Check Yahoo Finance for current stock prices. Finally, explain why your company's stock appears to be over-, under-, or correctly valued.
To help you with this assignment, please review the following:
As a manager, it is important to understand how decisions can be analyzed in terms of alternative courses of action and their likely impact on a firm's value. Thus, it is necessary to know how stock prices can be estimated before attempting to measure how a particular decision might affect a firm's market value.
To prepare for this Assignment, choose a publicly-traded company, and then estimate your company's common stock price, using one of the valuation models presented in the assigned readings or outside readings. (If you want to analyze a dividend paying company, you can find a robust list at http:/www.dividenddetective.com/big_dividend_list.htm.)
Defend your choice of model, and explain why it is appropriate to use for your company's stock. Be sure to explain how you arrived at any assumptions regarding values used in the model. Determine whether your company appears to be correctly valued, overvalued, or undervalued based on your company's stock current price and model result. Check Yahoo Finance for current stock prices. Finally, explain why your company's stock appears to be over-, under-, or correctly valued.
Step By Step Instructions - Week 4 Assignment
• Select a public company other than Pfizer.
• Go to finance yahoo
• Write down the information on the stock such as last closing price, beta of stock, EPS and Dividend in dollars and cents.
• On the left side of screen, click on Key Statistics under Company. Note ROE as you scroll down.
• You have the basic information to calculate the intrinsic value of the stock using the constant growth assumption in the Dividend Discount Model (refer to text readings).
• a) Calculate the required rate of return (r) for the stock using the Capital Asset Pricing Model (CAPM).
r = (10-year Treasury Bond Yield) + [Beta (S&P 500 Index Return - 10-year Treasury Bond Yield)]
Search for 10-year Treasury Bond Yield using the Search box at finance.yahoo.com.
S&P 500 Index Return for 2014 can be obtained at google.com. Since the return for 2015 was negative, we can use the 2014 value of 11.39%.
Plug in the data and calculate the required rate of return using the value for beta.
b) The constant growth rate of dividends, g = retention ratio x ROE
= (1 - payout ratio) x ROE
= [1 - (dividend per share/EPS)] x ROE.
g will be a percentage. Convert to a decimal by dividing by 100.
c) Intrinsic value of stock = Po = [Do (1 + g)]/(r - g)
Do is the dividend just paid while D1 = Do (1 + g) is the dividend to be paid.
Knowing Do or D1, r and g, you can calculate the intrinsic value.
Compare the intrinsic value above to the stock's current market price. Explain any differences using information gleaned by studying assigned text chapters.Tutors can assist you further if you schedule an appointment early in the week. These assignments do not lend themselves to last minute attempts.
Intrinsic value is a version of fair value of a stock. The market price is the current market price of the stock. The reasons for undervaluation or overvaluation relative to the intrinsic value of the stock can be varied. (Refer to text readings).
Below is an example. You have to select another stock and go through the process I have shown above. I posted information on stock valuation in Discussions. Study text readings and Weekly Dashboard supplementary information and provide reasons for overvaluation or undervaluation of your chosen stock. Address all questions for this assignment in your explanation. Include key figures in explanation and show calculations in Appendix. Show citations & references.
I chose Pfizer (PFE). I then went to finance.yahoo.com where I entered PFE in the Search Finance slot. Below is the information I received:
Pfizer Inc. (PFE)
NYSE
$34.25 Mar 20, 4:02PM EDT
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Beta:
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0.89
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P/E (ttm):
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24.09
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EPS (ttm):
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$1.42
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Div & Yield:
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$1.12 (3.30%)
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Use the 10-year Treasury bond rate for the riskfree rate of return = 1.93% at cnbcor search at google
S&P 500 Index return can be used for the market return = 11.93%. Check google.com for 2014 return.
r = 1.93% + [0.89 (11.93% - 1.93%)]
= 1.93% + 8.90% = 10.83%
Do = $1.12 - the dividend for last year
g = retention ratio x ROE
Payout ratio and ROE for Pfizer are given under Key Statistics in cnbc.com or finance yahoo
retention ratio = (1 - payout ratio) = (1 - 0.73) = 0.27 = 27%. Payout ratio was given in finance yahoo
ROE = 12.30% (given)
g = 0.27 x 12.30% = 3.32%. As a decimal, g = 3.32/100 = .0332
Po = [Do(1+g)]/(r-g) = [$1.12(1+.0332)]/(10.83% - 3.32%)
= ($1.12 x 1.0332)/(.1083 - .0332)
= 1.1572/.0751 = $15.48
Compare Po to current market price of $34.25. If the intrinsic value is the fair value based on assumptions of constant growth in dividends, the current market price shows overvaluation of Pfizer stock.
Study text readings and Weekly Dashboard supplementary information and provide reasons for overvaluation or undervaluation.
This is an example. You have to select another stock and go through the process I have shown above. Address all questions for this assignment in your explanation. Include key figures and show calculations in Appendix. Show citations & references.