1. Compare the stock prices estimated by the discounted FCF model to the actual stock price....

1. Compare the stock prices estimated by the discounted FCF model to the actual stock price. What recommendations can you make as to whether clients should buy or sell stock based on your price estimates from the discounted FCF method? Why?

2. Explain why the stock price estimate from the discounted FCF model differs from the actual stock price

Assume the stock price is $7 per share, actual stock price is $4 per share

Expert Solution

If the stock price as per FCF model is $7 per share, and the actual stock price is $4 per share:

Answer 1

~ The clients should BUY the stock.

~ Reason -

Since the Actual Stock Price ($4) is less than the Stock Price as per discounted FCF model ($7), the stock is undervalued in the market.

An undervalued stock should be bought, because if the client buys the stock today at the actual current price of $4, it will rise in the future to its intrinsic value of $7, hence benefiting those who bought it at $4.

Answer 2

The stock price estimate from the discounted FCF model can differ from the actual stock price, for the following reasons:

~ The intrinsic value (FCF model value) could be higher because of using a higher growth rate as compared to the implied growth rate of the market.

~ The intrinsic value could be higher because of using a lower required rate of return than implied return rate.

~ Overestimation of cash flow amount while calculating the Free Cash Flows under the FCF model valuation.

jeff jeffy answered 2 years ago

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