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,
BUS401 – Valuation Conclusion (Links to an external site.)
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.
 Compare your company’s beta to the market beta of 1.0.
 Calculate the companyspecific required rate of return using the CAPM formula.
 Show all calculations.
 Use the beta you determined for your chosen company
 Use a riskfree 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 midcap company (between $2.0 billion and $10.0 billion in market capitalization) use 8.0% as the market risk premium.
 For a smallcap company (less than $2.0 billion in market capitalization) use 11.0% as the market risk premium.
 Compare the companyspecific 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 companyspecific 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 lowend and the highend) 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 highend and lowend 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 highend and lowend 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 (lowend and highend) is above or below the current market price.
 State whether each recalculated stock price (lowend and highend) indicates if the stock price is currently undervalued or overvalued 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 highend stock price or the lowend 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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