02 Jul Finance Discussion Questions Set 3 DQ 3
Question Description
This Discussion Questions Set #3 (DQ 3) is on the valuation of common stock, which is related to Chapter 8. And, you will be using the Constant Dividend Growth Model, V = D1/ (k – g), to estimate the common stock value per share for your assigned company. That is, you will be required to find, step by step, the three parameters in the Constant Dividend Growth Model, i.e., D1, k, and g.
This Discussion Questions Set #3 (DQ 3) is on the equity valuation, which is related to Chapter 8. And, you will be using the Constant Dividend Growth Model, V = D1/ (k – g), to estimate the common stock value per share for your assigned company. That is, you will be required to find, step by step, the three parameters in the Constant Dividend Growth Model, i.e., D1, k, and g. The company listis attached at the end of this assignment.
Closely follow the instructions below:
1. Find “your company” from the attached file “Company List for Project 2”.
2. First, try to find D1by logging in to Yahoo Finance website: https://finance.yahoo.com/quote/TGT?p=TGT.
(1) The one shown there is for the Target company. You need to key in your company’s ticker symbol in the “Quote Lookup” box at the right hand corner to see your company’s summary.
(2) Look for the “Forward Dividend & Yield” in the summary table. The first number is the “forward dividend”. Use that as “D1”.
(3) If your company’s forward dividend number is “NA” or “0.0”, then use the “EPS (TTM)” number. But, you would need to use that EPS number multiplying by (1+g), i.e., one plus growth rate (which will be found in the following steps), to represent D1.The reason is that the EPS number that you get is the past EPS, not the forward earnings.
3. Find the growth rate, g:
(1) Click on “Analysis” on the blue option bar located below the stock price.
(2) Use either the growth rate for “Next Year” or for “Next 5 Years (per annum)” toward the end of that page under the “Growth Estimates”. Use either one of those two growth rate estimates as “g”. In one of the questions listed below, you would need to justify your using of one instead of another.
4. Find the required rate of return (i.e., discount rate) k:
(1) One way to find the required rate of return is by using CAPM model: k = kf + beta * (km -kf). Bu, you would need to find each of the parameters in the CAPM first, i.e., kf, km and beta.
(2) kf (risk-free rate):
A commonly used proxy for the risk-free rate, kf, is the 3-Month T-Bill Rates. You may find the current 3-month T-bill rate from the following link: (Use the most current rate)
https://ycharts.com/indicators/3_month_t_bill
(3) km (stock market average return):
Find the attached file “Market Data from Robert Shiller.xlsx”, and look at the “Return on S&P” column that has been highlighted in yellow. Calculate the average number of that series by selecting a period of time, e.g., from 1990 to 2012, by using the Excel function “Average”. Use that average as the average market return, i.e., km. (Note that you will be asked in one of the questions below why you selected to use that specific time period for calculating the average return for the market.)
** Note: The dataset attached has not been updated and ends on 2012. But, it provides you a general guide for the market return. By including more years up to date probably would not change the general trend in the average market return.
(4) beta:
You may find the beta for your company from the summary table of your company stock at the above Yahoo Finance website.
(5) Plug in all of those three numbers to the CAPM to find the required rate of return, k.
(6) Finally, plug in D1, g, and k into the Constant Dividend Growth Model to find the value per share for your company.
** Answer the following questions:
1. What is the value per share that you find for your company?
(1) Compare that with the current market price per share of your company from Yahoo Finance.
(2) Based on that comparison result, would you recommend people to buy your company’s stock? Why or why not?
2.For the growth rate estimate, g, above, which growth estimate did you use, the “Next Year” or the “Next 5 Years (per annum)”? Briefly explain why.
3.In the estimate for the market average return, km, why do you think the time period that you selected for calculating the average return is more appropriate to be used as the average return for the market in the future?
4.One of the basic assumptions in the Constant Dividend Growth Model is that the required rate of return, k, has to be greater than the growth rate, g. Is your k greater than g? If not, what other alternative(s) would you suggest to find the value per share for the company? (Note: You will not be able to use the Constant Dividend Growth Model if k is less than g, because the stock price cannot be negative).
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