Course Project

Part 7

Part 7 of the Course Project requires you to value your firm's equity based on Relative Valuation methods and Discounted Cash Flow valuation methods. Course Notes IV and V; class discussions of these Notes plus Chapter 17 of your text are important for Part 7.

The purposes of Part 7 are to enhance your knowledge of relative valuation and discounted cash flow valuation methods by providing you experience and practice in using them.

Course Project Part 7

Relative Valuation Using P/E and PEG Multiples, and DCF Valuation Using DCF Models.

Due Date: 5:00 PM Monday, December 6, 2014

Point Value: 40 points (an excellent opportunity to boost your grade)

Relative Valuation Method 1. Thisrequires:

(1)You to calculate your company's P/E ratio;

(2)Identify its peer/sector/industry companies;

(3)Calculate the P/E ratio for the peer/sector/industry;

(4)Value your company's stock using its earnings and the peer/sector/industry P/E;

(5)And then conclude whether or not your company's stock is over-valued, under-valued or properly valued.

Proceed as follows to obtain your company’s P/E:

  1. Your company's earnings:
  1. Use the Trailing Twelve Months (ttm) earnings per share. That is, EPS for Q3, 2014 + EPS for Q2, 2014 + EPS for Q1, 2014 + EPS for Q4, 2013.
  1. Your company's share price:
  1. Use the average price for the month of November, 2014
  1. Your company's P/E is derived by simply dividing the E from step 1 into the P from step 2.
  1. Your company's peer/sector/industry companies. This is a critical decision. Ideally the comparable peer/sector/industry companies should have similar RAOCCs, Capital Structures, Betas, Growth Rates, ROEs and Dividend Policies. As these reflect the strategy and execution of firms, we are ideally choosing firms with similar strategies.Explain the basis for your selection of peer/sector/industry companies. The “Holt” method might be the most straightforward to use here.
  1. Calculate the P/E for the peer/sector/industry. Use either the median or mean P/E of the group.
  1. Value your company's stock using the EPS ttm and the median P/E for the peer/sector/industry.

Relative Valuation Method 2 requires you to calculate your company's "PEG" ratio and to determine if its stock price is over-valued, under-valued, or properly valued.

Proceed as follows:

  1. Use your company's P/E ratio from above.
  1. Think seriously about your company's long-term earnings growth rate – the "g" in the PEG ratio. What is your best estimate of your company’s EPS growth rate over the next five years, 2015 - 2019? What are the earnings growth rates from references such as Value Line, S&P/Net Advantage, and Morningstar?
  1. The "g" can be roughly estimated as g = ROE x Retained EPS.

Total EPS

  1. Calculate your company's PEG ratio.
  1. How close is your company's PEG ratio to 1?
  1. How does the valuation in this part compare to that from Method 1?

Discounted Cash Flow Valuation

The following are the basic background data and information you need to estimate the DCF valuation for your firm’s stock price.

  1. The cash flow (s) to be discounted. Please note the following:
  1. If your company pays a dividend and has long-term debt in its capital structure then use a), b) and e) below as the cash flows in the DCF model.
  1. If your company does not pay a dividend and has no long-term debt then use b), c) and d) below.

a)Dividends per share.

b)Earnings per share.

c)Operating Cash Flow per share.

d)Free Cash Flow to the Firm per share.

e)Free Cash Flow to Equity per share.

  1. The RAOCC for your firm to discount cash flow d) and the Required Return on Equity to discount cash flows a), b), c) and e). This is from Course Project Part 6.
  1. Your best estimate - supported by your research, - of the growth rate(s) of the cash flows you will use for both the five year forecast horizon and the Terminal Value. Please discuss how you obtained these.
  1. It is critical for this part of the Course Project to have thought and researched long and hard about your company’s growth rate of cash flows. You need to discuss your best estimate(s) of its cash flow growth rate(s) and cite the research supporting your views.
  1. State whether you are using a No Growth/Perpetuity, Constant Growth Rate or Multi Stage Growth Rate DCF Model, and the basis for your decision.
  1. The forecast horizon is the 5 years 2014 – 2018; the Terminal Value part of the model starts in 2019.

Now, given the data and information from above use an Excel spreadsheet (templates are provided at the text web site) to show how you arrived at the DCF valuation for your company’s stock price. What does your model say your company’s stock is worth? How does this compare to its current market price?