As a new analyst for a large brokerage firm, you are anxious to demonstrate the skills you learned in your MBA program and prove that you are worth your attractive salary. Your first assignment is to analyze the stock of the General Electric Corporation. Your boss recommends determining prices based on both the dividend-discount model and discounted free cash flow valuation methods. GE uses a cost of equity of 10.5% and an after-tax weighted average cost of capital of 7.5%. The expected return on new investments is 12%.
Determine the long-term growth rate based on GE’s payout ratio (which is one minus the retention ratio. Use the long-term growth rate to determine the stock price for year five.
Determine the current stock price.
To determine the stock value based on the discounted free cash flow method:
Compute the three-year average of the following ratios:
Tax Rate (Income Tax Expense/Income Before Tax)
Property Plant and Equipment/Sales
Depreciation/Property Plant and Equipment
Net Working Capital/Sales
Create a timeline for the next seven years.
Forecast future sales based on the most recent year’s total revenue growing at the five-year growth rate from Yahoo! for the first five years and the long-term growth rate for years 6 and 7.
Use the average ratios computed in part (a) to forecast EBIT, property, plant and equipment, depreciation, and net working capital for the next seven years.
Forecast the free cash flow for the next seven years using. Determine the horizon enterprise value for year 5.
Determine the enterprise value of the firm as the present value of the free cash flows.
Determine the stock price.
Compare the stock prices from the two methods to the actual stock price. What recommendations can you make as to whether clients should buy or sell GE stock based on your price estimates?
Explain to your boss why the estimates from the two valuation methods differ. Specifically, address the assumptions implicit in the models themselves as well as those you made in preparing your analysis. Why do these estimates differ from the actual stock price of GE?
This question belongs to finance and discusses about analyzing the stock of a company and determining prices based on both the dividend-discount model and discounted free cash flow valuation methods.
Total word count: Excel
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