BUS401 Week 5 Discussion 1 Cost of Capital

 

In the constant growth formula, you can use the required rate of return on equity to determine the value of a share of stock. However, when you are computing the value of an investment project, you cannot assume the project is entirely funded by equity. Most businesses, and most projects, are funded with a combination of debt and equity financing. As a result, the discount rate for the project has to reflect the required rates of return for the debt holders and the equity holders. Analysts compute the weighted average cost of capital (the WACC) to value projects. The WACC is a weighted average of the required returns for the debt and equity holders, based on the proportions of debt and equity in the capital structure. In this discussion, you will practice calculating the WACC and interpreting its meaning and application.

Prepare:

Prior to beginning work on this discussion forum,

• Complete the Week 5 – Learning Activity.
• Read Chapter 10 in Essentials of finance.

Imagine that you own a company, Optimus, Inc., which is funded with 40% debt and 60% common stock; there is no preferred stock in the capital structure. The debt has an after-tax cost of 4%. You have studied the Electrobicycle project, and you believe that the auto company who has done the research and development (R&D) has made a crucial mistake. You believe that after the first 5 years, there will be worldwide expansion opportunities and many more years of revenues and earnings from selling Electrobicycles. Thus, you would not shut down the project in Year 5. Instead, you believe you will be able to sell the Electrobicycle business in Year 5 to a multinational company that will continue to produce the products and sell them internationally for many years into the future. You believe the sale of the Electrobicycle business in Year 5 will be for at least $15.0 million. Thus, you believe the value of the Electrobicycle project is significantly higher than the auto company realizes.

For the initial post,

• Calculate Optimus’ required rate of return on equity using the capital asset pricing model (CAPM). For the CAPM, use the following assumptions:
• Use a risk-free rate of 4.0%.
• Use 6.0% as the market risk premium.
• For the beta, use the beta below, according to the first letter of your first name

First Letter of First Name	Beta
A through B	0.30
C through D	0.40
E through F	0.50
G through H	0.60
I through J	0.70
K through L	0.80
M through N	0.90
O through P	1.00
Q through R	1.10
S through T	1.20
U through V	1.30
W through Z	1.40

 

• Calculate the WACC for Optimus. As a reminder, Optimus is funded with 40% debt and 60% common stock; there is no preferred stock in the capital structure. The debt has an after-tax cost of 4%.
• Use the Optimus required rate of return on equity that you calculated using the CAPM.
• Explain why it is appropriate for Optimus to value the Electrobicycle project using its WACC. Compare using the WACC to using solely the cost of equity in valuing the Electrobicycle project.

         

BUS401 Week 4 Section 4 Valuation Conclusion

 

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.

        

BUS401 Week 5 Mini Equity Research Report

Mini Equity Research Report

Company: Nike Inc.

Many investment banks employ analysts to write equity research reports on public companies to advise their clients on their stock investments. In many cases, an initial equity research report is 20 to 50 pages long! For this class, you will focus on only three of the many important sections typically included in an equity research report. Thankfully, your Mini Equity Research Report will be much shorter than those published by investment banks!

In Week 1, you chose a publicly traded company to use throughout this class for the Mini Equity Research Report. In the first section of the Mini Equity Research Report, you evaluate the historical financial performance of the company (Week 1). In the second section of the Mini Equity Research Report, you evaluate the company's performance using common financial ratios, and you compare the company to the competitor's performance with the same financial ratios (Week 2). Finally, in Sections 3 and 4 of the report, you develop a value for the company's stock and compare your value to the current market price of the stock (Weeks 3 and 4). Based on the analysis you present in these four sections, you will develop your recommendation to buy, hold, or sell the stock of this company.

It is very rare for one company to have only positive facts. Most companies have some good facts and some weak facts. In Sections 1 and 2 of the Mini Equity Research Report, you will analyze a variety of financial data for your selected company. As the equity analyst, it is your responsibility to combine the positive and negative facts into one recommendation (buy, hold, or sell). It is important to consider the importance of each fact and acknowledge that there is no perfect answer. Your recommendation should be based on the strength of the positive facts while recognizing the risks from the negative facts.

This week, you will write the introduction (including your stock recommendation) and the conclusion of the Mini Equity Research Report. In addition, you will revise the four sections from the first four weeks of class and combine them into this Mini Equity Research Report. Finally, you will submit your final Appendices A, B, C, and D with the Mini Equity Research Report.

 

Prepare:

Prior to beginning work on this final project,

• Complete the Week 5 – Learning Activity: Understanding Cost of Capital.
• Review the feedback you have received on your assignments throughout this course.
• Locate and revise (if necessary) all of your assignments from Weeks 1 through 4.

 

Write:

In your Mini Equity Research Report,

• Write an introduction. In your introduction, include the following:
• State the name of the company and a brief description of what it does.
• State the current market price per share and total market capitalization of the company.
• State two key historical financial performance facts about your company (you can ascertain this information from your Week 1 – Assignment 3, Section 1: Financial Statement Analysis).
• Categorize the overall financial performance as strong, neutral, or weak.
• Justify your assessment based on the key facts.
• Summarize (briefly) the ratio performance of the company.
• Categorize the overall ratio performance as strong, neutral, or weak.
• Justify your assessment based on the key facts.
• Determine the valuation conclusion based on the constant growth formula in Week 4, using the required rate of return derived from the CAPM.
• Determine your recommendation of buy, hold, or sell the stock of your chosen company.
• Include your revised Week 1 – Assignment 3, Section 1: Financial Statement Analysis.
• Include your revised Week 2 – Assignment 3, Section 2: Financial Ratio Analysis.
• Include your revised Week 3 – Assignment, Section 3: Dividend Analysis and Preliminary Valuation, Part 1: Dividend Analysis only
• Include your revised Week 4 – Assignment, Section 4: Valuation Conclusion.
• Write a conclusion. In your conclusion, include the following:
• Summarize the analysis that was completed for the Mini Equity Research Report.
• State your recommendation of buy, hold, or sell the stock of your chosen company.
• Summarize the key facts supporting your recommendation, including your concluded stock price.
• Include Appendices A, B, C and D.

 

Submission Format:

You need submit a total of five documents to Waypoint:

• Mini Equity Research Report
• Appendix A
• Appendix B
• Appendix C
• Appendix D

 

The Mini Equity Research Report,

• Must be eight to ten double-spaced pages in length including any tables or calculations (but not including title and reference pages) and formatted according to APA Style (Links to an external site.) as outlined in the Writing Center's APA Formatting for Microsoft Word (Links to an external site.)
• Must include a separate title page with the following:
• Title of project in bold font
• Space should be between title and the rest of the information on the title page.
• Student's name
• Name of institution (The University of Arizona Global Campus)
• Course name and number
• Instructor's name
• Due date
• Must utilize academic voice. See the Academic Voice (Links to an external site.) resource for additional guidance.
• Must include an introduction and conclusion paragraph. Your introduction paragraph needs to end with a clear thesis statement that indicates the purpose of your paper.
• For assistance on writing Introductions & Conclusions (Links to an external site.) as well as Writing a Thesis Statement (Links to an external site.), refer to the Writing Center resources.
• Must document any information used from sources in APA Style as outlined in the Writing Center's APA: Citing Within Your Paper (Links to an external site.)
• Must include a separate reference page that is formatted according to APA Style as outlined in the Writing Center. See the APA: Formatting Your References List (Links to an external site.) resource in the Writing Center for specifications. For help citing the information from Mergent, see the BUS401: Principles of Finance Research Guide.

          

BUS401 Week 3 Assignment Dividend Analysis and Preliminary Valuation

COMPANY: WALMART

Section 3: Dividend Analysis and Preliminary Valuation [WLOs: 1, 4] [CLOs: 1, 2, 4]

In the Section 3: Dividend Analysis and Preliminary Valuation assignment, you will compute the of the company's stock value based on historical dividend data for your company and a market-based equity rate of return. In this analysis, you will use the constant growth formula to compute two estimates of the stock price, a high-end value and a low-end value. Analysts frequently assess the stock value using a range of values, based on reasonable assumptions for a high-end and a low-end range.

Once you have calculated two stock values, you will compare the company's calculated values compared to the current market price of the stock. This comparison will help you determine if the stock is currently under-valued or over-valued, and will help you determine your recommendation of buy, hold, or sell. Analysts prepare value estimates based on historical data for the company as well as an understanding of expected future equity rates of return. It is important to understand that the constant growth formula provides an estimate of value, and analysts, like all humans, can be both right and wrong. The inputs used in the formula will greatly impact the value conclusion.

 

Prepare:

Prior to beginning work on this assignment,

• Complete both learning activities for this week.
• Review Chapters 4 and 5 of the textbook.
• Review the Week 3 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: Dividend Analysis (two to three paragraphs):

• Create a table that illustrates the annual dividends per share paid by your selected company over the past 10 years. If the company has not paid dividends for 10 years, include as many years as available.
• Calculate the growth in annual dividends per share each year and include this annual growth rate in your table. 
• To find the dividends your company has paid in the past 10 years, review the BUS401 |Picking a Company that Pays Dividends (Links to an external site.) video from Week 1.
• Calculate the average dividend growth rate over the following periods: 
• the most recent 10 years, 
• the most recent 5 years, and
• the most recent 3 years.
• Summarize the trend in the dividend growth rates.
• Have the dividend growth rates increased or decreased? By how much? Has the increase or decrease been steady or varied from year to year?
• Determine two distinct estimates of the future dividend growth rate for this company: a high-end growth rate and a low-end growth rate. You are to choose these growth rates based on what is reasonable from the data you have on the company's dividend growth in prior years, as presented in your table. The two future dividend growth rates can be any of following: 
• the most recent year growth rate; 
• the average growth rate over the 10-year period;
• the average growth rate over the most recent 5 years;
• the average growth rate of the most recent 3 years; or
• a growth rate you select that is reasonable, given the 10-year, 5-year, and 3-year averages, as well as the recent year growth rates.
• NOTE: Both dividend growth rates must be lower than the required rate of return used in the constant growth formula. See Part 2 below for the required rate of return to use in the constant growth formula.
• Justify the determined the high-end dividend growth rate and low-end dividend growth rates for your company. In your justification, provide a least two financial facts from your Week 1 and Week 2 assignments to support your determination.

Part 2: Preliminary Valuation: (two to three paragraphs)

• Calculate the stock price for your selected company using the constant growth formula and the low-end dividend growth rate you determined in Part 1. Show all calculations for this estimated stock price using the low-end dividend growth rate.
• For the required rate of return (r), use the following assumptions:
• For a large capitalization company (greater than $10.0 billion in market capitalization) use 10.0%.
• For a mid-cap company (between $2.0 billion and $10.0 billion in market capitalization) use 12.0%.
• For a small-cap company (less than $2.0 billion in market capitalization) use 15.0%.
• Show your calculations.
• In a similar manner, calculate another estimate of the stock price for your selected company using the constant growth formula and the high-end dividend growth rate.
• Use the same assumptions for the required rate of return (r) that you used for the low-end stock price, other than using the high-end dividend growth rate.
• Show your calculations.
• Compare each of the two stock prices you just calculated to the current stock price per share of the company.
• State whether each constant growth stock price (low-end and high-end) is above or below the current price.
• State whether each constant growth stock price (low-end and high-end) indicates if the stock price is currently under-valued or over-valued in the market.
• Determine your concluded stock value, based on the two calculations using the constant growth formula.
• Justify your conclusion of value for your stock, using either the high-end stock price or the low-end stock price from the constant growth formula. Include least two financial facts from your Week 1 and Week 2 analyses.

The Section 3: Dividend Analysis and Preliminary Valuation paper

• Must be three to four double-spaced pages in length including any tables or calculations (but not including title and references pages) and formatted according to APA Style (Links to an external site.) as outlined in the Writing Center's APA Formatting for Microsoft Word (Links to an external site.) resource).
• Must include a separate title page with the following:
• Title of paper in bold font
• Space should be between title and the rest of the information on the title page.
• Student's name
• Name of institution (The University of Arizona Global Campus)
• Course name and number
• Instructor's name
• Due date
• Must utilize academic voice. See the Academic Voice (Links to an external site.) resource for additional guidance.
• Must include a separate references page that is formatted according to APA Style as outlined in the Writing Center. See the APA: Formatting Your References List (Links to an external site.) resource in the Writing Center for specifications.
• Must cite where the financial statement information comes from (i.e., Mergent)
• For help citing the information from Mergent, see the BUS401: Principles of Finance Research Guide.

Note: Since this is Section 3 of the Week 5 final project, there is no need for an introduction paragraph.

COMPANY : WALMART