Question

Stock Valuation, the WACC and the CAPM

Compute the intrinsic value of two stocks and compare the values to the reported market stock price in order to determine if the stock is undervalued or overvalued.   

You should do the following:

• Select any two U.S. public companies that pay dividends (required to use the dividend discount model)
• Compute each stock’s required rate of return using the Capital Asset Pricing Model.
• Compute the current period WACC for the selected firms
• Compute the intrinsic stock price using the Discounted Dividend Model
• Discuss whether the stocks are undervalued or overpriced.
• Discuss the models used and their limitations, if any.
• Extract analysts’ opinions of the firm’s stock value from available sources and compare to your results
• Discuss the discrepancies between the computed and actual stock prices.
• Make recommendations based on your findings.
• Does it make economic sense to purchase the stocks given the intrinsic values, financial health of the companies, and the industry outlook? You must use logic and objective argument to support your decision.

Answer 1

Source": Reuters
	Apple			GM
Risk free rate	2.39%			2.39%
Beta	1.13			1.30
risk premium	7.9%			7.9%
Rate of return or Cost of equity	11.3170%			12.6600%
Dividend growth	10.80%			5.09%
Expected return = Risk Free Rate + [Beta x Market Return Premium]
last dividend paid	$2.90			$1.51
next year dividend based on growth rate	$3.21			$1.59
Intrinsic stock price	divident/(cost of equity-dividend growth)
so, intrinsic value =	$         621.509			$ 20.960
So using CAPM, cost of equity	11.32%			12.66%
Current stock price	$            189.95			$    37.10
so after computing the intronsic value, I believe for Apple stock price is undervalued while for GM stock price is over valued
WACC
tax rate	0.51			0.51
Cost of Debt =	3240 / 115081.5 = 2.8154%	0.028154		655 / 99585 = 0.6577%	0.006577
After tax cost of debt	1.380%			0.322%
weight of equity	= 895667.436 / (895667.436 + 115081.5)	0.8861	52291.668 / (52291.668 + 99585) = 0.3443	0.3443
weight of debt		0.1139		0.6557
WACC	WACC=E/(E + D)*Cost of Equity+D/(E + D)*Cost of Debt*(1 - Tax Rate)
therefore WACC	10.19%			4.57%
Intrinsic stock price
last dividend paid	2.9			1.51
next year dividend based on growth rate	3.2132			1.586845
Intrinsic stock price	divident/(cost of equity-dividend growth)
so, intrinsic value =	621.5087041			20.95968
So using CAPM, cost of equity	0.11317			0.1266
Current stock price	189.95			37.1
so after computing the intronsic value, I believe for Apple stock price is undervalued while for GM stock price is over valued
Discuss the models used and their limitations, if any.
The DDM model has two short comings,
1. it consider constant divident growth
2. the output value is quite snsititive to fluctuate as the denominator is very less tchnically
WACC model has following shortcomings-
1. WACC model does not consider the risk assessment into picture
Considering the values calculated usign the models, I belive it make sense to purhcase stock of apple, considering its
intrinsic value is quite less than stock price. So perceived value can give good returns in future.
using same principle, GM should not be purchased