Reference no: EM131298002

Finance Theory and Practice

Stock Valuation project

The purpose of the project is to estimate and justify: (1) an intrinsic (fundamental) value for the company of your choice and (2) the fundamental price/share of equity in the firm. You should attempt to justify that you have calculated your best estimate of the firm's stock price. You may compare your values (ratios/prices/calculations, etc.) to those you find on the internet, but your work should be your own and your job is to calculate these figures. All calculations/ratios/values are assumed to have been calculated by you own. You should not substitute those figures for yours and using such figures from other sources is plagiarism. All of your reports (including table, graph, figures, reference, etc) should not be longer than 25 pages.

You may use up to three different methods to calculate firm stock value (the FCF method is most important and you have to include this analysis in your project). The three methods that we study for valuing corporations include:

1. Free Cash Flow Method (or discounted cash flow method). This method requires you to produce pro forma financial statements as based upon the additional funds needed, percentage of sales and constant ratio methods (see "Financial forecasting" in the index). The pro forma statements are then used to calculate the free cash flow as based upon the formulas/examples in the: "Financial Statements, Cash Flow and Taxes," "Financial Planning and Forecasting Financial Statements," and the "Corporate Valuation," chapters in the text. The FCF is discounted back to the present by the WACC, which leads to the firm value as follows. Note that the present value of the FCFs = the Value of Operations (see the CH 7 and the formula runs as followings).

Value of Operations (Enterprise Value )

+ Value of non-operating assets (one example would be marketable securities)
= Total Firm value
- Value of Debt [we use the book value of ST and LT debt; though theory suggests that the market value
- Value of Preferred Shares [if any]
= Value of Equity
÷ Number of Shares of Common Stock outstanding

Price per share

This price per share is your estimate of the fundamental value of the firm stock, which you would then use to argue that the firm is either currently over/under/fairly valued according to the market, i.e., by comparing your price/share to the current market price/share. Warren Buffet calls this estimate the "intrinsic value" of the firm. Remember that you may consider the efficient market hypothesis in relation to your price estimate.

2. Dividend Growth Model (Multi-stage growth model)

3. Comparables (Stock Price Multiples Model): This method is relatively easy and provides some useful valuations that often set the ranges for the stock price. The course packet lecture entitled "Using Stock Price Multiples to Estimate Stock Price" describes this method. You may use either a direct competitor or industry averages. For example, if you are analyzing Ford Motor Corp. it would be appropriate to use GM as a comparable firm (and/or the auto industry). Note that sector/industry ratios can be obtained on Yahoo.finance [look under profiles, then on the left hand side under Financial Links you should see competitors]. Many different financial ratios can be used, although the P/E and Price/CF ratios are common. Another alternative is to create your own "industry" averages from a diverse group of firms within the industry. You are limited only by your creativity; and a great deal of information is available on the Internet. The goal should be to calculate fundamental values by yourself.