Signature Assignment: Justifying the Market Value of a Company
All aspects of the course come together this week. Business valuation is the process of determining the market value of an entire company, whether public or private. Theoretically, the market value of a business enterprise is equal to the present value of all cash flows that the firm (i.e., the collection of assets) is expected to generate in all future time periods. Expected future cash flows can be estimated using accounting data (as you learned in Weeks 3 and 4), factoring in both microeconomics factors (e.g., demand characteristics for the firm’s products and/or services, costs of production, labor supply, etc.) and macroeconomic factors (current and projected economic growth, interest rates, inflation, unemployment, etc.). You learned present value techniques in Week 6 and how to estimate the required rate of return to discount cash flows at in Weeks 5 and 7.
Determining the market value of a publicly-traded corporation is actually very simple. The market value of equity is just the price per share of the company’s common stock times the number of shares outstanding and the market value of debt can be effectively estimated as being equal to the book value of debt (this is valid as long as interest rates are relatively stable). Then, according to the identity equation, the market value of the business enterprise (i.e., the market value of the firm’s assets) equals the market value of debt plus the market value of equity. Therefore, the market value of a publicly-traded corporation is mainly determined by the market value of its equity (since the book value of debt is mostly constant for a short period of time).
Be sure to review this week’s resources carefully. You are expected to apply the information from these resources when you prepare your assignments.
Week 8 – Assignment: Signature Assignment: Construct a comprehensive company review and report
Assignment
Task: Submit to complete this assignment
Due September 9 at 11:59 PM
This week, you will attempt to justify the market value of a publicly-traded firm by investigating the equity value of the company. Using the dividend discount model, determine the implied long run growth rate of the firm from its stock price and its expected rate of return as implied by the capital asset pricing model. Then, using all that you have learned in the class to this point, evaluate whether the implied growth rate is reasonable or not.
Assume that you were not hired last week after making your presentation to the board. This was not because your presentation was bad. Instead, the day after your presentation the company was indicted by the SEC for financial statement manipulation. Fortunately for you, one of the board members (who had nothing to do with the accounting oversight of the company) was so impressed with your presentation that she has recommended you for the CFO position at another company. This company has asked you to prepare a comprehensive report that evaluates the company’s current market valuation.
There are several parts to this assignment. Be sure to carefully follow all of the instructions in each part.
Part I:
Choose another company (similar to the way you chose a company for Week 3). This company must be in a different industry from the company you previously chose and the company must be publicly traded (i.e., you must be able to find the company’s current stock price). Find and read the company’s most recent annual report. Write about three paragraphs describing the company. Discuss the company’s line of business, products and/or services offered, time the company has been in operation, and main location. Discuss any other aspects of the company that you believe are particularly interesting about the company.
Part II:
Assess the company from a microeconomic point of view. Discuss the demand characteristics for the company’s product or service (e.g., the company’s customers, competition, etc.), the company’s cost structure (e.g., degree of variable cost versus fixed costs), and the nature of the industry (highly competitive, somewhat competitive, oligopoly, or monopoly). Discuss any other microeconomic factors that you believe are relevant to the company.
Part III:
Evaluate the current macroeconomic situation in the U.S. Do economists seem to believe we are in a recession, period of slow growth, or in an economic boom? What is the projected growth rate for the economy over the next year? Are there any current proposals by the President or Congress (that seem like they may be enacted) that will affect the future of the economy, and might influence the company? If so, what and how might they affect the company?
Part IV:
Conduct a ratio analysis of the company, similar to the what you did in Week 3, but only do Parts II, III and VI of the Week 3 assignment.
Part V:
Create a proforma income statement for the company in order to estimate net income for the next annual accounting period (you only have to create a proforma income statement, not a proforma balance sheet). Divide your value for projected net income by the number of shares of common stock outstanding (you will find this number in the annual report), to determine projected earnings per share (i.e., EPS).
Part VI:
Find the company’s beta (you can find this online in many sites. Note that you can find a significant amount of additional useful information about your company at this site by clicking and reviewing each of the tabs just below the stock price information (Summary, Conversations, Statistics, Profile, Financials, Options, Holders, Historical Data, Analysts). Explain what the beta tells you about the relative risk of the company. Does this make sense in light of your discussions in Parts II and III? Why or why not?
Assuming a current risk-free rate of 2.5% and a market risk premium (i.e., Rm – Rf) of 8.0%, determine the required rate of return for the company using the capital asset pricing model (CAPM).
Part VII:
Using the valuation model discussed in Kaen (2003) on page 58:
P0 = D1/(k−g)
and assuming that the projected EPS that you computed in Part V = D1 (this means that the company will distribute all net income as dividends next year) and the required rate of return that you computed in Part VI = k (expressed as a decimal), solve for g given today’s stock price. For example, if the current price of the company’s stock (you can find this on the yahoo site mentioned in Part VI) is $20.00, you projected EPS to be 2.00 and you determined the required rate of return to be 14% (i.e., .14 as a decimal), then you would solve for g in the equation:
20.00 = 2.00/(.14 − g)
Thus, you would find that g = .04 = 4%. Show all of the steps that you use to solve for g for your company (expressed as a percent). This is the long run growth rate implied by this model, your proforma estimate for net income and the estimated required rate of return suggested by the capital asset pricing model.
Part VIII:
Scroll to the bottom table titles “Growth Estimates.” Find the “Next 5 Years (per annum)” value for your company. Compare that to what you determined for g in Part VII. Is the analysts’ projected value greater than or less than the value you found? Provide several reasons (written out in several paragraphs) for why these values might differ?
Part IX:
Based on your comprehensive evaluation of your chosen company, would you want to be the CFO of this company or not? Provide reasons for why you would or why you would not. (Note: Although you must include Part IX in what you submit for this assignment, this item will not be included in the final comprehensive report that will be given to the company.)
Length: 12-15 pages, excluding title page and references
References: Include a minimum of five scholarly resources.
Your report should demonstrate thoughtful consideration of the ideas and concepts presented in the course by providing new thoughts and insights relating directly to this topic. Your response should reflect scholarly writing and current APA standards. Be sure to adhere to Northcentral University’s Academic Integrity Policy.
