capital asset pricing model

capital asset pricing model

Estimate the firm’s cost of equity using the capital asset pricing model (CAPM). Justify each input usedfor your calculations.ii. Compute an intrinsic value of the company’s common stock using both of the valuation methods listedbelow. Identify the values used for all variables in your model, and clearly identify all datasources. Multiple sources for the same data element are encouraged.You must compute an intrinsic value of the stock using both valuation methods listed below:1) Dividend growth model: constant dividend growth with an infinite horizon (below). Usingthe cost of equity you calculated in part i), compute an intrinsic value for the stock. Be sureto justify your assumed dividend growth rate (g).2) Relative valuation: identify at least three (3) close competitors of your selected company thatoperate in the same industry and also have publicly-traded stock.a) Calculate the following ratios for your firm and for each competitor: price toearnings (P/E), price to sales (P/S), and price to free cash flow (P/FCF). Forreference, Chapter 2 of the textbook refers to free cash flow as “cash flow fromassets,” which is equal to operating cash flow, minus capital expenditures and netchange in working capital. Show your work for how you calculated each ratio.b) Find the average value of each ratio for the group of competitors you selected. Besure to exclude any outliers or extremely unrealistic values when computing theaverage.c) Apply each average ratio that you calculated in step b) to the associated value of thefirm you are analyzing to compute an implied stock price. For example, multiply theaverage P/E ratio of the competitor group by your firm’s earnings per share to getan implied stock price.i. Example: you have calculated the average P/E ratio (that is, stock pricedivided by earnings per share, EPS) of your firm’s competitors to be 18.Multiply 18 by your firm’s EPS of $2.25. Using the rules of fractionmultiplication, the EPS terms cancel out, and you are left with an impliedstock price (P) for your firm.1. Price/EPS = 18 (average of competitors)2. 18(Price/EPS) x $2.25(EPS) = $40.50(Price) the implied stock price ofyour firm is $40.50ii. Apply the exact same process for P/S (stock price divided by revenue pershare, or market cap divided by revenue) and P/FCF (stock price divided byfree cash flow per share, a.k.a cash flows from assets from Chapter 2 – ormarket cap divided by free cash flow)1. Competitor average(P/S) x Your firm’s revenue(S) = implied stockprice of your firm2. Competitor average(P/FCF) x Your firm’s cash flow(FCF) = impliedstock price of your firmiii. In your written report, discuss each of the following items:a. Compare the computed intrinsic values of your firm’s stock with the most recent actual stockprice. Analyze why these values are different – speculation is encouraged.b. Assess the advantages and disadvantages of each stock valuation method.c. Compare the value of your firm’s ratios (e.g. P/E) to the average ratio of the competitor group,and discuss why your firm’s ratios may differ. Why do you think your firm is trading at apremium (higher ratio) or a discount (lower ratio) compared to its competitors? What uniquecharacteristics, opportunities, or potential risks of your firm may be driving this discrepancy?

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