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This assignment is a walk through a set of financial data for a hypothetical company. It will help the to understand better the theoretical background behind the calculation of stock prices and the reaction of prices to market forces such as risk and interest rates. Please use the CAPM (capital asset pricing model) and the constant growth model (CGM) to arrive at the stock price of this hypothetical company.
Please show all work, including formulae and calculations used to arrive at financial values.
• Find an estimate of the risk-free rate of interest (rf). To obtain this value, go to:
Use the current "U.S. 10-year Treasury" bond rate as the risk-free rate. In addition, you also need a value for the market risk premium. Go to http://www.bloomberg.com/quote/SPX:IND to obtain the year to date return on the S&P 500. Use this return as the expected market return (do not confuse the terms expected market return and market risk premium. Look at the material/videos in D2L to help explain the difference between the two).
• Open the Assignment 4 - Stock Date file. Using the information from the document, record the following values:
o XYZ's beta (ß)
o XYZ's current annual dividend
o XYZ's 3-year dividend growth rate (g)
• With the information you recorded, use the CAPM to calculate XYZ's required rate of return (rs).
• Use the CGM to find the current stock price for XYZ, after substituting the required return above. Call this the theoretical price (Po).
• Now look in the stock information again, to find XYZ's current stock quote (P). Compare Po and P and answer the following questions:
o Are there any differences?
o What factors may be at work for such a difference in the two prices?
Your submitted assignment must include the following:
o All of the numerical values listed in the assignment guidelines.
o Your answers to the 4 questions in the assignment guidelines.
o The formulas and calculations that you used to arrive at your answers
• A neatly prepared and formatted MS Excel document, where each tab, or sheet, corresponds to each of the 4 questions above. Students must include your explanation of how you used Microsoft Excel for your calculations.
Please show value calculations as well as the demonstrated understanding of CAPM, CGM, and stock analysis. Please be well-organized, and neat. Please show detailed work in easy to read and understand. Please explain your thought process, clearly.
The first thing we do is find the risk free rate. From the website you've supplied, the 10 year treasury bill rate today is 2.61%. We use this as the risk free rate.
Next, we find the YTD return of the S&P500. The YTD return listed on Bloomberg is 19.26%.
Recall that Market Risk Premium = Expected Return of the Market - Risk-Free Rate, thus Market Risk Premium = 19.26 - 2.61 = 16.65%.
Now, we look at the company's financial:
current dividend = $0.8
3 year dividend growth rate = 8.2%
This is all the background information we need, we are now ready to begin the calculation part.
Recall that CAPM says E(r) = rf + beta(market risk premium), so E(r) = 2.61 + 1.64(16.65) = 29.92%
The expert examines capital asset pricing models for financial markets.