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You are a new analyst for a large brokerage firm....

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Question

You are a new analyst for a large brokerage firm. You are anxious to demonstrate the skills

 

you learned in your MBA class and prove that you are worth your attractive salary. Your

 

first assignment is to analyze the stock of the General Electric Corp. Your boss

 

recommends determining prices based on both the dividend-discount model and discounted

 

free cash flow valuation methods. The expected return on a new investment is 12%.

 

However, you are a little concerned because your finance professor has told you that these

 

two methods can result in widely differing estimates when applied to real data. You are

 

really hoping that the two methods will reach similar prices. Good luck with that!

 

1- Go to Yahoo! Finance (http://finance.yahoo.com) and enter the symbol for General

 

Electric (GE). From the main page for GE gather the following information and enter it

 

onto a spreadsheet:

 

a. The current stock price (last trade) at the top of the page

 

b. The current dividend amount, which is in the bottom-right cell in the same

 

box as the stock price.

 

2- Next click on \"Key Statistics\" from the left side of the page. From The Key Statistics

 

page gather the following information and enter it on the same spreadsheet:

 

a. The number of shares, of stock outstanding

 

b. The Payout ratio

 

3 .Next click on \"Analyst Estimates\" from the left side of the page. From the Analyst

 

Estimates page find the expected growth rate for the next 5 years and enter it onto your

 

spreadsheet. It will be near the very bottom of the page.

 

4. Next click on \"income Statement\" near the bottom of the menu on the left. Place the

 

cursor in the middle of the income statement and right-click. Select \"Export to Microsoft

 

Excel.\" Copy and paste the entire three years of income statements into a new worksheet in

 

your existing Excel file. Repeat this process for both the balance sheet and cash flow

 

statement for GE. Keep all the different statements in the same Excel worksheet.

 

5. To determine the stock value based on the dividend-discount mode:

 

a. Create a timeline in Excel for five years.

 

b. Use the dividend obtained From Yahoo! Finance as the current dividend to

 

forecast the next 5 annual dividends based on the five-year growth rate.

 

c. Determine the long-term growth rate based on GE\'s retention ratio and the return on

 

new investment.

 

d. Use the long-term growth rate to determine the stork price for year five

 

(using dividend discount model)

 

e. Determine the cost of equity using the CAPM model. (note: use

 

http://finance.google.com/finance) to get the beta of the stock. Assume risk free rate =

 

3% and market risk premium = 7%.

 

f. Determine the current stock price using (using dividend discount model)

 

6. To determine the stock value based on the discounted free cash flow method:

 

a. Forecast the free cash flows (for seven years) using the historic data from

 

the financial statements downloaded From Yahoo! To build your forecast, compute

 

the three-year average of the following ratios:

 

i. EBIT /Sales

 

ii. Tax Rare (Income Tax Expenses /Income Before Tax)

 

iii. Property Plans and equipment/Sales

 

iv. Depreciation Expenses/ Property Plans and Equipment

 

v. Net Working Capital /Sales

 

b. Create a timeline for the next seven years

 

c. Forecast future sales based on the most recent year\'s total revenue growing

 

at the five year growth rate from Yahoo for the firs five years and the longterm

 

growth rate for years six and seven

 

d. Use the average ratios computed in pare (a) to forecast EBIT, Property

 

Plans and Equipment, depreciation, and net working capital for the next

 

seven years.

 

e. Forecast the free cash flow for the next seven years

 

3

 

f. Calculate the WACC by calculating the weights of debt and equity and the cost

 

of debt and equity.

 

To Calculate the weights: determine the amount of debt and equity,

 

calculate the total capital (sum of debt and equity), then, calculate the weights

 

of debt and equity.

 

To calculate the cost of debt, calculate the after tax cost of debt using the

 

information on http://bonds.yahoo.com/ (note: you should search by the

 

company name \"GENERAL ELECTRIC CO\"). Assume a marginal tax rate of 30%.

 

Cost of equity is determined based on the CAPM model (as in 5-e)

 

g. Determine the value of the firm based on discounted free cash flow

 

h. Determine the value of equity by subtracting long term debt from the firm

 

value

 

i. Determine the stock price

 

7. Compare the stock prices from the two methods to the actual stock price. What

 

recommendations can you make as to whether clients should buy or sell General

 

Electric\'s stock based on your price estimates?

 

8. Explain to your boss why the estimates from the two valuation methods differ.

 

Paper#5423 | Written in 20-Dec-2015

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