A new analyst for a large brokerage firm, you are anxious to demonstrate the skills you learned in your MBA program and prove that you are worth your attractive salary. Your first assignment is to analyze the stock of the General Electric Corporation. Your bossrecommends determining prices based on both the dividend-discountmodel and discounted freecash flow valuation methods. GE uses acost of equity of 10.5% and an after-tax weighted average cost ofcapital of 7.5%. The expected return on new investments is 12%.However, you are a little concerned because your finance professorhas told you that these two methods can result in widely differingestimates when applied to real data. You are really hoping that thetwo methods will reach similar prices. Good luck with that! Go to Yahoo! Finance http://finance.yahoo.com and enterthe symbol for General Electric (GE). From the main page for GEgather the following information and enter it ontoaspreadsheet: a. The current stock price (last trade) at the top of thepage. b. The current dividend amount, which is in the bottom-rightcell in the same box as the stock price. Next click on “Key Statistics” from the left sideof the page. From the Key Statistics page gather the followinginformation and enter it on the same spreadsheet: a. The number of shares of stock outstanding. b. The Payout ratio. Next click on “Analyst Estimates” from the leftside of the page. From the Analyst Esti-mates page find theexpected growth rate for the next 5 years and enter it onto yourspreadsheet. It will be near the very bottom of the page. Next click on “Income Statement” near the bottom of the menu on the left. Place the cursor in the middle of the income statements and right-click. Select “Export to Microsof tExcel.” Copy and paste the entire three years of incomestatements into a new work-sheet in your existing Excel file.Repeat this process for both the balance sheet and cashflowstatement for General Electric. Keep all the different statementsin the same Excel worksheet. To determine the stock value based on the dividend-discountmodel: a. Create a timeline in Excel for five years. b. Use the dividend obtained from Yahoo! Finance as thecurrent dividend to forecast the next 5 annual dividends based onthe five-year growth rate. c. Determine the long-term growth rate based on GE’spayout ratio (which is oneminus the retention ratio) using Eq.9.12 (g=retention rate x return on new investment) d. Use the long-term growth rate to determine the stock pricefor year five using Eq.9.13. (Pn = Div / (r - g) e. Determine the current stock price using Eq. 9.14. To determine the stock value based on the discounted free cashflow method: a. Create a timeline in Excel for five years. i. EBIT/Sales ii. Tax Rate (Income TaxExpense/Income Before Tax iii. Property Plant andEquipment/Sales iv. Depreciation/Property Plant andEquipmentv.Net Working Capital/Sales b. Create a timeline for the next seven years. c. Forecast future sales based on the most recentyear’s total revenue growing at the five-year growth ratefrom Yahoo! for the first five years and the long-term growth rate for years six and seven. d. Use the average ratios computed in part (a) to forecast EBIT, property, plant and equipment, depreciation, and networking capital for the next seven years. e. Forecast the free cash flow for the next seven yearsusing Eq. 9.18. f. Determine the horizon enterprise value for year5 using Eq. 9.22. Po = Vo + Cash - Debt / Shares Outstanding g. Determine the enterprise value of the firm as thepresent value of the free cash flows. h. Determine the stock price using Eq. 9.20. Compare the stock prices from the two methods to the actualstock price. What recommendations can you make as to whetherclients should buy or sell General Electric’s stock based on your price estimates? Explain to your boss why the estimates from the two valuation methods differ. Specifically address the assumptions implicit in the models themselves as well as those you made in preparing your analysis. Why do these estimates differ from the actual stock price of GE?

## This question was asked on Jan 17, 2013.

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