A2: Estimate Stock Returns:Students will select 2 companies in different industries and will estimate the relative valuation and the expected return for the companies through the use of the Capital Asset Pricing Model.

Estimating Stock Returns

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Project Outline and Tasks:

Select two companies in two different industries and do the following:

Provide background information on the company and describe the industry in which the company operates in and its main products.

Determine key macroeconomic factors impacting each firm.

List and describe the major competitors to the selected company. Evaluate each firm using Porter’s 5 determinants of competition.

Compute and interpret the financial ratios described below for a five-year period.Look at the trend in the ratios to determine if they are deteriorating or improving and compare them against peers or the industry:

Current and quick ratios and net working capital

Inventory turnover, fixed assets turnover and total assets turnover

Debt ratio and TIE.

Gross profit margin and net profit margin and operating margin

ROE and ROA

Price/ Earnings and Market/Book

Du Pont Analysis

Find beta, R squared, alpha and the residual standard deviation for each firm using Excel. Interpret the results and recommend which firm should be added to a well diversified portfolio.Use 60 months of return data for the calculations.

Find the correlation between the two stocks and interpret.

Estimate the required return for each stock (SML).

Estimate the sustainable growth rate (g) for each stock. Find it for 3 years and take an average.

Estimate the 5 and 10-year historic growth rate in earnings. Compare to sustainable growth method.

Estimate the intrinsic value (price) of the two stocks using the 1) dividend discount model (DDM) approach and the 2) P/E multiplier approach.Make a buy or sell recommendation.

Evaluate stock using value criteria of dividend yield and price to book.

Use the Black-Scholes model to find the value of a call option and the value of a put option for each stock