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BAFI 1045 Investment Company Valuation Assignment
Part 1: Financial Performance and Current Issues (10%)
In this section, students are expected to provide:
• An evaluation of the company’s brief recent history and financial performance over time and also include peer group analysis.
• Conduct ROE for the company following the DuPont ROE approach and include peer group comparison.
• An analysis of the current issues facing the company, the industry it operates in, and explain the impact of the issues on the company’s future earnings.
Part 2: Valuation Models (25%)
The second part/section of the assignment should contain the estimation of the value of the company’s share using:
? Dividend valuation model (DDM)
? Free Cash Flow to Equity model (FCFE)
? Price/Earnings Ratio model (P/E)
? Price/Book Value Ratio model (P/B)
You areexpected to use the Capital Asset Pricing Model (CAPM)- discussed intopic 3
– to estimate the required rate of return or discount rate needed for each model. For CAPM estimation, you are required to calculate the following:
1. Beta: You cannot pick a beta value estimated elsewhere (e.g., Bloomberg) and use it in your report. Follow topic 3 lecture notes and relevant chapter (chapter 8) of the prescribed textbook to estimate the beta of the company and attach details of your work as an appendix.
Also adjust the raw beta using appropriate methodology (refer to topic 3 lecture notes).
2. Risk-Free Rate: Use10 years Govt. Bond Yield as a proxy for the risk-free rate. Indicate any advantages or disadvantages if there are any.
3. Market Risk Premium: The estimation of the expected market risk premium is crucial. You must carefully explain what you do and any assumption you make while estimating market risk premium.
• Risk Premium Estimation
To estimate the risk premium, first, you have to estimate the expected market return. Assume that expected return on the market portfolio is related to a Macroeconomic variable, e.g., GDP. Then use the expected changes in the macroeconomic variable, with appropriate possible returns and appropriate probabilities (assume these returns and
probabilities based on your analysis of current economic condition) to estimate expected return on the market portfolio. Then, subtract the RFR from the expected market return and arrive at your market risk premium.
Once you estimate these three figures (1-3) you will be able to estimate the required rate of return or discount rate following CAPM that can be used in valuation models.
Important points to be covered in Part 2:
• Explain any assumptions made in implementing the models.
• Where appropriate, explain how you arrived at the variables you are using. E.g., it is not enough to say you are assuming a 2 percent growth rate. You would be expected to provide justification/motivation of how you arrive at 2 percent growth rate.
• Provide an indication of the sensitivity of your valuations to changes in the assumptions. E.g. perform sensitivity analysis
for each model.
Part 3: Evaluation/Discussion of the value/price of the company (5%)
Comment on your valuations from part 2, including a discussion of possible explanations of why your valuations differ from the current/recent share price. If appropriate, discuss why some of the above models may be unsuitable for valuing the company.
Maximum word limit for the Company Valuation Assignment is 10,000 words.
Note:
Every single member of the syndicate is expected to do a part of implementing the
valuation models. That is to say, there should not be the situation where a member
only does the history and financial performance of the company without any input in
the actual implementation of valuation model.
The focus of this assignment is on the valuation, specifically generating the inputs
into the valuation process and applying valuation models to these inputs to arrive at a
range of share price estimates. The requirements outlined above have been designed
to aid this process.
For the discounted cash flow valuation models the primary requirement is to produce
the appropriate expected return measures and discount rates to use in the models. For
the relative valuation techniques the focus is on estimating the appropriate ratio
multiples.
It is important that forecasts of expected returns reflect the impact of the factors
identified as current issues facing by the company. A common mistake is to identify a
range of issues which will impact on the company’s future earnings or cash flows, but
then produce a set of return forecasts which are simply extrapolations of historical
returns, ignoring the impact of the factors identified as current issues. The
development of return estimates requires judgement; it is not simply a statistical or
mathematical forecasting exercise.
References/Resources for group assignment
Reilly, Frank K. and Keith C, Brown, Investment Analysis and Portfolio Management (10 th Edition), Thomson South-Western (2012): Chapters 10, 11, 12, 13, and 14.
[Much of the material in these chapters is covered in earlier courses and these chapters should be used for revision purposes].
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