Work the Web Part-4, Instructions :
Beta estimation, cost of equity & stock price estimation.
You will use some of the techniques discussed in Chapters 7 and 11 to estimate beta, required return and then
estimate the stock price.
You will need to use/submit two files for this assignment : one Word file and one Excel file. The WW4 report
(Word file) will include the following :
• Beta estimation with real data, other available betas
• CAPM estimation of required return
• DDM estimation of expected return
• Price calculation, market equilibrium
Please find the attached XL file (SampleWW4.xlsx).
Please refer to this sample file so you understand what you must do for your company.
Estimation of beta with historical prices
In your Excel file you need to get historical prices for at least 61 months. It is recommended to use full years so at
this time, you should calculate monthly returns from January 2011 to December 2015 With this information you will
estimate the regression line which will provide you with your beta estimate. You will compare this number to the one
you got from Reuters for WW2 and you will also compare against the one in Yahoo (summary page) and the one in
MSN Money (summary page) Comment on any possible differences and take an average that will be used for CAPM.
Required return estimation – CAPM
To apply the Capital Asset Pricing Model you will get a recent quote of 10 year Treasury bond rate and will use it
as your Rrf. For the Market Risk Premium you can use any number between 5 and 7 percent. Personally I recommend
5.5 percent. For your beta, you will use the average of the 4 estimates you got.
Expected return estimation – Dividend Growth Model & target prices
The formula for expected return is Div Yield + Long term dividend growth rate Use the number you got in WW3
to estimate the expected return for your company.
Compare the 2 rates (required rate from CAPM) and the expected rate (from the discounted dividend model) and
conclude whether the stock is overvalued or undervalued (whether you should buy or you should sell) based on your
estimate of LT growth.
Summary page in Yahoo ! Finance has a one-year Target price. This is the price that is expected by analysts at
the end of the year. This number can be used as a reference and allows us to gauge how optimistic stock analysts are.
We use the Dividend amount and the target price to estimate analysts’ expected return as (D + P1)/Po. This number
can be compared against your own DGM expected return and against the CAPM return.
Price calculation, expected prices & market equilibrium
Refer to chapter 7 and using the most recent yearly dividend for your company, the estimate for g that you got
in WW3 and the required return from CAPM, estimate the fair value for the stock of your company. Compare your
estimate with current stock price and state if you recommend buying or selling the stock.
1
– Work the Web project : Part 4 2
Finally, another useful comparison that can be used to find overpriced or underpriced stocks is to determine the
equilibrium growth rate for the company. You assume that CAPM holds and based on the required return, and current
dividend yield you obtain what the “market” is expecting for long term growth of a company’s dividends. You compare
that against your own estimated growth rate for the company and determine how optimistic current investors in the
company are. If investors are expecting LT growth rates > 25%, this suggests a bubble is in place and caution should
be exercise when investing in that company.
Methodological Notes :
• This model has a restriction on the value of g that can be used in calculations of stock price. First, Rs has to be
higher than g.
• In addition, because of the high sensitivity of the model, I recommend that your estimates for g are at least 1%
lower than the Rs obtained from CAPM.
• If your estimate for g obtained in WW3 was too high and you got negative stock prices, it means that one of your
assumptions was wrong. Now that you know the required rate of return, do you need to change your estimate
of g ? If so, do it and calculate a valid, positive stock price