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** Please see attached file for the problem information **

Use the information on the pages to provide a "fair price" for the securities.

© BrainMass Inc. brainmass.com October 5, 2022, 1:24 am ad1c9bdddf

## SOLUTION This solution is FREE courtesy of BrainMass!

We use need both the DDM and CAPM to evaluate each of the ten stocks. However, note that ddm is not applicable for some of the stocks. I will point those out when we get there.

First, we need the current interest rate. From Finance.yahoo.com, we can find the current 10 year gov't bond yields 2.997%. For ease of calculation, we say that the current rate, r, is 3%.

Lastly, let me remind you the formulae for ddm and capm.

DDM: p = d/(r-g), where p is price, d is annual dividend, r is interest rate and g is dividend growth rate.

CAPM: Expected return = risk free + beta[expected market return - risk free]

Expected market return is found on pg 2 and is PRICE CHANGE-YTD = 7%.

We begin calculating price of ATT

By CAPM, expected return = 0.03 + 0.24(0.07 - 0.03) = 0.0396. This number is the expected return (also called required return) of the company. To value their shares using DDM, we must use the required return of this company, not the market interest rate.

By DDM, price = 1.59/(0.0396 - 0) = 40.15, since growth rate of dividend is not given. Compare to the actual price, we are about \$15 off.

CCW

expected return = 0.03 + 0.53(0.07 - 0.03) = 0.0512

price = 1.75/0.0512 = 34.18.

PHR

expected return = 0.03 + 1.74(0.07 - 0.03) = 0.0996

price = 2.25/0.0996 = 22.59

SSWXC

No information is given, so we cannot try to calculate its fair price using our models. We must accept the fact that the market price is in fact its fair price. SO price = 27.65

T

expected return = 0.03 + 0.76(0.07 - 0.03) = 0.0604
price = 1.72/(0.0604 -0.06) = 4 300

This one is way off! This is because that the growth rate of the last 5 years is 6%. But it is extremely unlikely that the company will continue to increase its interest by 6%/yr in the future. Since DDM only considers constant growth rates, this is likely where the problem is.

CMCSA

expected return = 0.03 + 1.13(0.07 - 0.03) = 0.0752
price = 0.45/(0.0752 -3) = 9.96.
This one is even worse! The growth rate is 58%. If we plug that into ddm, it will return negative stock value. We have to assume that in the future the stock will grow at the current interest rate (very bad assumption), but without much more information, we have make such strange assumptions.

PRU

expected return = 0.03 + 2.25(0.07 - 0.03) = 0.12
price = 1.15/(0.12 + 0.04) = 7.19.

This is an interesting one, the growth rate is negative. Again, the growth rate cannot be negative forever, so our valuation is clearly wrong. This is one of the limitations of DDM.

SSW

expected return = 0.03 + 1.81(0.07 - 0.03) = 0.1024
price = 0.5/0.1024 = 4.88

AAPL

expected return = 0.03 + 1.03(0.07 - 0.03) = 0.0712

The company pays no dividend, so DDM does not apply. The DDM is really bad with tech stocks, because they don't pay dividends most tech companies will reinvest their earnings for R&D instead of paying them to shareholders.

ABT

expected return = 0.03 + 0.46(0.07 - 0.03) = 0.0484

price = 1.92/(0.0484 - 0.03) = 104.35.

Again, because growth rate is so high, we are forced to make some assumptions.

This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

© BrainMass Inc. brainmass.com October 5, 2022, 1:24 am ad1c9bdddf>