Choose a publicly traded company and then estimate its company\'s common stock p

Question

Choose a publicly traded company and then estimate its company's common stock price, using one of the valuation models presented in the assigned readings or outside readings. (I choose exxon-mobil and the Dividend Discount Model)

Defend the choice model, and explain why it is appropriate to use for the company's stock. Explain how you arrived at any assumptions regarding values used in the models. Determine whether Exxon-Mobil appears to be correctly valued, overvalued, or undervalued based on its stock current price and model result. Check yahoo Finance for current stock price.

Use the Dividend Discount Model to evaluate Exxons common stock price.

Explanation / Answer

We have chosen Apple Inc. for the given assignment. To provide recommendation of this stock as an investment opportunity, Stock price analysis is done in the following document. Stock Price has to be calculated for the analysis to be done. First of all, Cost of equity will be calculated using CAPM (capital asset Pricing Model), this model describes the relationship between the risk and expected return and that is used in the pricing of the securities. The following is the formula:

Ke=Rf+?*(Rm-Rf)

Where, Ke is cost of equity

Rf is Risk free rate of return

Rm is Expected market return

? is a measure of risk

For Apple Inc.,

Risk free rate = 2.47%

Beta = 0.74

Expected market return= 12.63%

Ke= 2.47%+0.74*(46.17%-2.47%)

Ke= 0.34808=34.808%

Now, with Ke= 34.808%, Let us calculate the stock price, using Gordon Growth model. This model is used to compute the price of the stock, based on a future series of dividends, based on a growth rate. The following is the formula,

Stock value (P) = D1// (Ke-g)

Where, D1 is Expected dividend per share one year from now,

Ke is Cost of Equity,

g is growth rate.

First of all, Let us compute the growth rate,

Growth rate (g) = Retention ratio (b) * Rate of return(r)

Retention ratio = (1- Dividend payout ratio)

Dividend Payout ratio= DPS/EPS

=$11.40/$40.03

=0.2847

Retention ratio (b) = 1-0.2847= 0.7153

Rate of Return(r) = Net Income/ Shareholder’s equity

=$37,037/$123,549

Rate of Return(r) =0.2997

Growth rate (g) = 0.7153*0.2997

=0.2144

Growth rate=21.44%

Expected Dividend (D1) = Do*(1+g)

D1= $11.40*(1+21.44%)

D1=$13.84

Now, Stock Price= $13.84/ (34.80%-21.44%)

Stock Price (Intrinsic value) = $134.02

The idea behind the CAPM is that the investors need to be compensated in both time value of money and risk. The time value of the money is considered in the risk free rate, and the risk is considered by taking a risk measure beta that compares the return of the asset to the market premium and the return of the asset to the market over a period of time i.e. (Rm- Rf)

Since, the Market price at which the stock is selling in the market is $132.04 and the intrinsic value is $134.02. So, it is recommended to buy the stock as the stock is sold at a price less than its intrinsic value. It is always preferred by the investors to buy a good stock at a discounted price. So, it is the right time for our client to buy the stock, which is selling at $134.02 in the market. So, the stock is under-priced in the market as the stock is sold at a price less than its intrinsic value.

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