Company Nike
In this assignment, you will
recalculate the value of the company’s stock based on your company’s specific
required rate of return. To do this, you will calculate the required rate of
return for your chosen publicly traded company using the capital asset pricing
model (CAPM).
Last week, you determined a
preliminary estimate of the company’s stock price using the constant growth
formula. To simplify the calculation, you were required to use general market
required rates of return, based on size. However, this is an assumption that
does not account for the specific risk of an investment in a specific company.
This week, you will calculate the required rate of return for your chosen
publicly traded company using the CAPM. The CAPM is a more precise tool to estimate
a firm’s required rate of return. This tool is “tremendously valuable because
required returns are used as the discount rates in the valuation formulas when
doing time value of money problems and security valuation” (Hickman et al.,
2013, Section 9.3, para. 1). You will then use this CAPM required rate of
return to revise your stock price value based on the constant growth formula.
This will allow you to determine your final recommendation of buy, hold, or
sell.
Prepare:
Prior to beginning work on this
assignment,
- Complete both of the Week 4 learning activities
- Review Chapters 7 and 9 of Essentials of
finance.
- Review the Week 5 - Final Project.
- Review the Week 4 Model
Assignment (Links to an external site.).
- Watch the following video:
Write:
In your paper, address the following
five parts in a Word document:
Part 1: (two paragraphs)
- Explain the three types of risk and beta, and how these
concepts relate to a company’s required rate of return.
Part 2: (two paragraphs)
- Find your company’s beta from a credible source.
- You can get this information from the Mergent database
or by looking it up on a financial website like Yahoo! Finance (Links to an external
site.).
- Compare your company’s beta to the market beta of
1.0.
- Calculate the company-specific required rate
of return using the CAPM formula.
- Show all calculations.
- Use the beta you determined for your chosen company
- Use a risk-free rate of 2.0%.
- For the market risk premium, use the following
assumptions:
- For a large capitalization company (greater than
$10.0 billion in market capitalization) use 6.0% as the market risk
premium.
- For a mid-cap company (between $2.0 billion and $10.0
billion in market capitalization) use 8.0% as the market risk premium.
- For a small-cap company (less than $2.0 billion in
market capitalization) use 11.0% as the market risk premium.
- Compare the company-specific required rate of return
you calculated to the required return based on size you used in Section 3:
Dividend Analysis and Preliminary Valuation in Week 3 for the constant
growth formula.
- Determine whether the company-specific required rate
of return higher or lower than the rate of return based on size that you
used in Section 3 in Week 3 for the constant growth formula?
- Explain the difference in required rate of returns.
Part 3: (two to four paragraphs)
- Recalculate both estimates (the low-end and the
high-end) of the stock price using the constant growth formula.
- Use the company’s specific required rate of return you
determined using the CAPM.
- Review your selected high-end and low-end growth rates
from Week 3.
- If either growth rate is higher than the new CAPM
discount rate, you must reduce your selected growth rate(s).
- Your growth rates cannot be higher than the discount
rate, because the calculations will result in a negative stock price,
which is not meaningful.
- Include a short, written explanation to explain the
revised growth rates.
- Show your revised high-end and low-end stock price
calculations
- Compare each of the two recalculated
stock prices to the current stock price per share of the company.
- State whether each recalculated stock price (low-end
and high-end) is above or below the current market price.
- State whether each recalculated stock price (low-end
and high-end) indicates if the stock price is currently under-valued or
over-valued in the market.
- (See Section 9.3: Required Returns in your course
text.)
- State your recommendation for your concluded stock
price for the company.
- Use either the high-end stock price or the low-end
stock price from the constant growth formula using the CAPM required rate
of return.
- Justify the conclusion of value for your stock based on
the most important financial facts from the prior weeks’ analysis.
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