INTERMEDIATE FINANCIAL MANAGEMENT
Part I:
This section should include information about your company. The following points need to be covered in this section. Please feel free to include tables and figures, as you deem necessary. Do not forget to label the tables and figures. When stating financials and any numbers, please do cite the source and the date as of when these numbers are true.
1. Company overview. This sub-section should include the following information:
i) Brief history of the company. Headquarters and places of operation.
ii) Major products and services. Is the firm a market leader in any of these product(s) or service(s)?
iii) Segment data - major business segments and revenue breakdown for the most recent year(s).
iv) Major competitors both at the firm level and at the segment level. What criteria did you use to identify competitors?
v) Industry overview - Recent trends and forecasts on growth prospects. If your firm operates in multiple business segments, do this analysis for each segment.
vi) Any other pertinent information such as the number of employees, interesting facts about your company etc.
2. Market Data and Ownership Structure. Document the following information for the most recent year (or later data if available). Source: Bloomberg Security Description; Annual report.
i) Major (Top 5 to 10) stockholders in the company
ii) Where is the company listed? Is the company listed on more than one stock exchange?
iii) What percent of the stock do institutional investors hold? How does this number compare to industry averages?
iv) What percent of the stock do executives hold? How does this number compare to industry averages? What are the implications of a higher (lower) executive ownership?
3. CEO and the Board of Directors - Bloomberg security description
i) Who is the CEO of your company? How long has he or she been CEO?
(1) Was the CEO hired from within the firm? What was his/her career path?
(2) How did the firm's stock perform since the CEO start?
ii) What are the major committees in the company?
iii) What proportion of directors are outsiders? - What do the terms inside and outside directors mean? Why is this distinction important?
iv) What proportion of directors are CEOs of other companies?
4. Code of Ethics and Corporate Social Responsibility (CSR)
i) Is the code of ethics available on company website and/or annual report? Please read through this and summarize in one or two paragraphs.
ii) Does your company engage in any CSR related activities? Please summarize in one to two paragraphs. More information, if available, is welcome.
iii) Was your company / top executives accused or found guilty of any fraudulent or unethical activities in the recent past? Provide a one to two paragraph summary of the action and the consequences.
Part II
This section involves estimating costs of equity, debt and ultimately the weighted average cost of capital for your firm. The objective is to expose you to the choices available for the input variables used in these calculations, and to the several decisions you have to make in the process. It is very important that you clearly identify the input values and sources and your reason for choosing these inputs over available alternatives.
1. Cost of Equity using capital asset pricing model (CAPM): You need estimates of risk-free rate, market premium and stock beta to calculate cost of equity using CAPM.
i) Risk-free Rate: Choose an appropriate risk-free rate (for ex. 10-year T-Bond rate)
ii) Market Premium: Estimate two measures of market premium.
(1) Historical premium calculated as average market premium for the last 10 years. Market premium for each year can be calculated as (Return on S&P index - 10 year treasury bond). Example:
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Jan 1 2016
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Dec 31 2016
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Return
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S&P
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2,000
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2,200
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(2,200-2,000)/2,000 = 10.0%
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Ten year treasury
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2.2%
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2.2%
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Market Premium for 2016
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7.8%
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(2) Implied (forward looking) premium calculated using the following data
(a) Price - value of S&P500 index as of January 2, 2018
(b) Total cash returned by S&P 500 firms during the year. (total cash = dividends + share buybacks). This data is available on S&P website. S&P releases this information once every three months.
(c) S&P 500 growth forecast for the next five years (yahoo finance. Enter your company ticker; go to analyst forecasts and look for earnings growth forecast for the next five years. Your company's growth forecast and S&P 500 growth forecast are available)
(d) Use the excel sheet provided by me to estimate implied premium.
iii) Beta: Estimate two measures of stock beta.
(1) Run a regression using Bloomberg interface. (Type Beta in Bloomberg and enter relevant the following values in the prompts - market index - S&P 500 index; frequency - monthly; period: January 01, 2012 - December 31, 2017.
(2) Run a regression using Excel. Download adjusted close price data for S&P 500 and your company from yahoo finance. Calculate returns and run a regression and perform the regression analysis using Excel.
Please incorporate the following in your write-up:
- Any adjustments you made in the calculation of historical premium (outliers, arithmetic vs geometric averages etc)
- Your idea behind why historical and implied premiums are different.
- Compare the intercepts and slopes from Bloomberg and regression. Are the results similar or different? If different, mention a few reasons that could be driving these differences.
- Focus now on your regression results and discuss the following.
- What is the slope of the regression?
- What does it tell you about the risk of the stock?
- How precise is the estimate of risk? (use the standard error of the beta estimate to construct a 95% and 99% confidence interval)
- What portion of this firm's risk can be attributed to market factors? (look at the R2 for this)
2. Estimate Cost of Debt using the following methods. Try to estimate all three measures subject to data availability.
i) Use the yield on company's long-term bond outstanding as the pre-tax cost of debt. Use a long-term straight bond with no convertible features for this purpose. (Source: Bloomberg fixed income)
ii) Estimate cost of debt from financials (interest expense from income statement and long-term + short-term debt outstanding from balance sheet)
iii) Use the cost of debt associated with the firm's current credit rating (i.e., default spread associated with the rating plus 10-year treasury rate. Most recent default spreads are available on Prof. Aswath Damodaran's website)
3. Weighted average cost of capital (WACC). Use costs of equity and debt from your calculations and proportion of debt and equity from annual report or Bloomberg.
In your write-up, you may want to incorporate the following:
a) Discussion about the current capital structure including any recent equity and bond issues.
b) Summary of what numbers (and as of what date) you are using to calculate WACC.
c) It is very likely that the WACC from Bloomberg and WACC you calculated will be different. What factors may have led to these differences?
d) Get industry-averages and discuss your firm's capital structure with respect to industry averages.
Section III
This section involves evaluating and discussing the dividend policy of your firm. Use the following guidelines for this exercise.
- For the latest year (last five years recommended), estimate how much cash (dividends + buybacks) has been returned to shareholders. Source: Annual report or Bloomberg.
- Estimate how much cash could be returned to shareholders - FCFE is a good proxy. You can calculate this measure or use publicly available figures or get it from Bloomberg
- Compare dividends and FCFE to determine whether the firm is paying too much or too little dividends.
- Evaluate performance of firm/management over the last five years using one or more of the following performance benchmarks
- ROE vs Cost of Equity during the last five years
- ROA vs WACC during the last five years
In your write-up, you may want to incorporate the following:
a) Discussion about the current dividend policy; how the policy has changed over the last few years.
b) Any recent dividend increases / bonus dividends / buybacks (and if you can, how the stock market reacted to these announcements and what you make of that reaction).
c) Compared to FCFE, is the firm paying too much or too little dividends?
d) Discussion about firm performance in the recent years.
e) Based on this analysis, provide a recommendation on how the firm should alter its dividend policy. It may be helpful to look at the breakdown of FCFE of your firm to get an idea of the driving factor behind FCFE.
Questions
1) Is there a minimum length requirement?
2) What if I cannot find information on a specific topic or question?
3) What sources should I use?
4) Should I write everything in my own words? Is there an acceptable length I can copy and paste?
Written Report Guidelines
- Writing style: MLA format recommended. At the minimum, the report needs to contain
- Title page (may contain your company's logo).
- Table of contents, list of figures and tables.
- Properly numbered sections and sub-sections.
- Consistent font and formatting style. Font size 12 or greater (Times New Roman) and one-and-a-half line spacing.
- Tables and graphs should be self-explanatory (i.e., with proper titles and legends).
- Try to avoid pasting pictures from external sources such as yahoo or Bloomberg as much as possible.
- Lengthy calculations / tables can go into the appendix.
- Tables can be placed inside the text or at the end in an order.
- Due to the nature of the project there are not many references - Your primary sources of data are your firm's annual report, Bloomberg database and Yahoo Finance.
- However, you are required to choose among several choices while picking data and variables (e.g., the measure of profitability you use, type and date of risk-free return you use etc). You should clearly state which measure/variable you are using, its source and the reason you chose this measure/variable as opposed to similar alternatives.
Feedback: The following feedback will be provided on the written projects:
- Peer reviews. Two or three peer reviewers will review Parts 1, 2, and 3 of your project and provide comments to help you prepare your second draft. Peer reviewers are expected to provide constructive criticism and thoroughly review the paper. Students are expected to take peer reviewer comments into consideration when preparing the second draft of the paper.
- Meetings with writing center: Students who have difficulty in written English should use all available resources throughout the course of the semester to make sure they are making satisfactory progress in the written part of the course project. Please do not expect us to help you out extensively in the last week of classes.
- Instructor feedback provided students submit a complete draft one week prior to each of the peer-reviews. A complete draft adheres to all the written report guidelines mentioned above.