Calculate cost of equity using capm

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Reference no: EM1378354

Requirements

As a starting point, download the Valueline research report for your company. This research report provides historical data as well as some future estimates. For current market data for your stock, use finviz.com or finance.yahoo.com or any other data provider.

1. HPR vs. CAPM or Intrinsic Value

a. Calculate cost of equity using CAPM. Use the rate on the 30-year T-bill for the risk free. Use 5.2% for the market risk premium (unless you have a better idea - just justify it).

What is your best estimate for your company's cost of equity? Why?
(Note if the beta's provided are very different you must choose one, or you can decide to take an average of the two. Alternatively, you can calculate it yourself or check out other sources for Beta. Whatever you do, justify it.)

b. For HPR, use estimated values for price and dividends for next year.

2. Valuation using multiples
a. Find the average P/E for your company's industry from the spreadsheets.
b. Use these P/E and earnings from Valueline or from finance.yahoo.com to come up with 3 estimates for your stock.

3. Calculate the intrinsic value of the stock using the one-stage dividend growth model
a. For growth rate use ROE*b. Use Valueline's estimate for ROE for next year and plowback for next year. (This will only work if the growth rate is less than the market capitalization rate. If you come up with a negative price for your stock, that is likely because the growth rate is greater than k and your stock is not suited for the one-stage model. If this is the case for your stock, explain why you think this is so in the write-up.)

4. Calculate the intrinsic value of the stock using a multi-stage dividend growth model (Step-by-step example of this is in the Lifecycle and Multi-stage Growth Models" section of Chapter 13 in the text book.)
a. Use estimates from Valueline for the dividends over the next 3 years.
b. Terminal Value Estimates - this is the final price estimate for you model. You are going to calculate it these three different ways:

i. Use constant growth model with ROE and plowback given from Valueline (values in the last column) to calculate the sustainable growth rate. If this results in a negative number, it may mean that your company will still not be in a constant growth phase. Does that make sense to you? Explain.

ii. Use constant growth model with average historical inflation rate (3.21%) as your estimate for "g" and calculate terminal value using constant growth model.

iii. Use valuation using multiples -- Use the P/E estimate and EPS estimate for the final 3 years of Valueline data (last column) to calculate terminal value. Multiply the P/E by the EPS.

Results and Recommendation

5. Compare all of your estimates for your stock's value.

a. Do you think your company is over-/under-/correctly- valued.

b. What is your best guess for the fair value of the stock (you can provide a NARROW range)?

c. Is there a particular valuation method that you think makes the most sense for your company? Explain. (For example, is your company more likely to be in the constant growth stage now or do you think that the multi-stage model is a better fit?) (Note: you should not choose the model BECAUSE its resulting value is closest to the market price. Think about what makes sense given your company's life stage and growth outlook.)
d. Look at P/E and PEG ratio, does this support or contradict your findings in this model?

6. Can you make a buy/sell/hold recommendation? How confident are you with your recommendation?

Reference no: EM1378354

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