14 Jun Question 3) Apply the Capital A
Question
3) Apply the Capital Asset Pricing Model (CAPM) Security Market Line to estimate the required return on Home Depot stock. Note that you will need the risk-free rate and the market return. Show this information in your project. (15% of the project grade)
1. Apply the Capital Asset Pricing Model (CAPM) Security Market Line to estimate the required return on stock. Note that you will need the risk-free rate, beta, and the market return.
a) To get the current yield on 10-year Treasury securities go to www.finance.yahoo.com -click on Markets – U.S. Treasury Bonds Rates. You will use the current yield on 10-year Treasury securities as the risk-free rate to estimate the required rate of return on stocks. Discuss how appropriate this rate is as a measure of risk.
b) Between 1926 and 2014, the compound annual rate of return of S&P 500 is estimated a 7.5%. We will use this number as the market return. Discuss how appropriate this rate is as a measure of return.
c) Beta is listed in HYPERLINK”http://www.finance.yahoo.com” \t “_blank” www.finance.yahoo.com under Trading Information – Stock Price History, as well as on the company’s front page. What is the beta listed for the company? What does it mean?
d) Calculate the required return on the stock using the Capital Asset Pricing Model (CAPM) Security Market Line. Please show your work.
2. There are several methods how to calculate the growth rate. One of the possible ways is to calculate the sustainable growth rate as g = ROE *(1- Dividend payout ratio). You can find ROE and the dividend Payout Ratio on HYPERLINK “http://www.finance.yahoo.com” www.finance.yahoo.com under Statistics.
Calculate the company’s sustainable growth rate. Please show your work.
3. Apply the Gordon model (constant growth rate model) to calculate the intrinsic (economic) value of the stock. Please show your work.
Please note that for some companies it is not possible to use the Gordon model. If that is the case, please explain why it is not possible to use this model for your company. What other models is it possible to use?
4. Compare the result of your calculations with the current stock price. Is the stock overvalued, undervalued, or properly valued? Why? In accordance with your findings, is it reasonable to buy the stock? Why? Please explain your answer.
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