Use the constant growth model and supernormal growth model to obtain stock values for your company.  

Determine the discount rates (expected returns) using the CAPM model (Hint: you’ve already calculated the firms’ betas in part one of the project).   For this project, assume the risk free rate is 2% and the market risk premium is 7.5%.  Use analyst’s earnings forecasts from a reputable source (e.g. most likely Yahoo but possibly Zacks, Value Line, Etrade, etc.) to determine expected growth rates.  (You may use the simplifying assumption that the dividend payout ratio will remain constant. 

This means that the expected growth rate for earnings will equal the expected growth rate for dividends.)  For the constant growth model, use the 5-year earnings growth rate (I suggest you choose between Past 5 years and Next 5 Years if using Yahoo Analyst Forecasts) as your proxy for the dividend growth rate.  Make sure you consider how reasonable this rate is particularly if it is negative or excessively large. This is a judgment call. One way to think of what to do is to reflect on what are the main underpinnings of the model, what are they based on and what is needed for the model to work properly – what assumptions are being violated by the real data you are using. 

For the supernormal growth model, use the projected growth rate for current and next fiscal year earnings to estimate your growth rates for years one and two and then use the same 5-year historical earnings growth rate you used.  the constant growth rate. Similar to the normal growth rate, consider how reasonable these rates are particularly if they are large negative figures. In the event, the 5-year earnings growth rates are higher than required rate of return on the stock or you come to the conclusion that they are unreasonable, review the various growth rates in your ratio analysis and choose a rate that is lower than the required return. Be sure to list the source of the expected growth rate.

 After computing the values, compare them to the recent price of the stock and indicate whether your calculations suggest that the company is under-valued or over-valued.  Also, provide a brief discussion regarding your confidence in using these models to value “real-world” companies.

Answer rating: 100% (QA)

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