Last week, you determined a preliminary estimate of the company’s stock price using the constant growth formula. To simplify the calculation, you were required to use general market required rates of return, based on size. However, this is an assumption that does not account for the specific risk of an investment in a specific company. This week, you will calculate the required rate of return for your chosen publicly traded company using the CAPM. The CAPM is a more precise tool to estimate a firm’s required rate of return. This tool is “tremendously valuable because required returns are used as the discount rates in the valuation formulas when doing time value of money problems and security valuation” (Hickman et al., 2013, Section 9.3, para. 1). You will then use this CAPM required rate of return to revise your stock price value based on the constant growth formula. This will allow you to determine your final recommendation of buy, hold, or sell.

Prepare:

Prior to beginning work on this assignment,

Complete both of the Week 4 learning activities

Review Chapters 7 and 9 of *Essentials of finance*.

Review the Week 5 – Final Project.

- Review the
*Week 4 Model Assignment*. - Watch the following video:

- Write:

In your paper, address the following five parts in a Word document:

- Part 1: (two paragraphs)

Explain the three types of risk and beta, and how these concepts relate to a company’s required rate of return.

Part 2: (two paragraphs)

- Find your company’s beta from a credible source.

You can get this information from the Mergent database or by looking it up on a financial website like *Yahoo! Finance*.

Compare your company’s beta to the market beta of 1.0.

Calculate the company-specific required rate of return using the CAPM formula.

Show all calculations.

Use the beta you determined for your chosen company

Use a risk-free rate of 2.0%.

For the market risk premium, use the following assumptions:

For a large capitalization company (greater than $10.0 billion in market capitalization) use 6.0% as the market risk premium.

For a mid-cap company (between $2.0 billion and $10.0 billion in market capitalization) use 8.0% as the market risk premium.

For a small-cap company (less than $2.0 billion in market capitalization) use 11.0% as the market risk premium.

Compare the company-specific required rate of return you calculated to the required return based on size you used in Section 3: Dividend Analysis and Preliminary Valuation in Week 3 for the constant growth formula.

Determine whether the company-specific required rate of return higher or lower than the rate of return based on size that you used in Section 3 in Week 3 for the constant growth formula.

Recall that in the required rate of return (*r*) in Week 3 was assumed to be:

- 12.0% for a large capitalization company.

15.0% for a mid-cap company.

18.0% for a small-cap company.

Explain the difference in required rate of returns.

- Part 3: (two to four paragraphs)

Recalculate the estimate of the stock price that you completed in Week 3 using the constant growth formula.

- Use the company’s specific required rate of return you determined using the CAPM in Part 2 of this assignment.

Review your selected growth rate from Week 3.

If the growth rate is higher than the new CAPM discount rate, you must reduce your selected growth rate.

- Your growth rate cannot be higher than the discount rate, because the calculations will result in a negative stock price, which is not meaningful.
- Include a short, written explanation to explain the revised growth rate.

Show your stock price calculation.

- Compare the recalculated stock price to the current stock price per share of the company.
- State whether the recalculated stock price is above or below the current market price.
- State whether the recalculated stock price indicates if the stock price is currently under-valued or over-valued in the market.
- (See Section 9.3: Required Returns in your course text.)

State your recommendation for your concluded stock price for the company.

- Use either the stock price from the constant growth formula using the CAPM required rate of return or the current market price.
- Justify the conclusion of value for your stock based on the most important financial facts from the prior weeks’ analysis.
- Need Help?
- Sturggling? Click the tutoring button below to get immediate help with content-related questions or issues.

- Don’t know what to ask the tutor? How about…

I don’t understand that capital asset pricing model. Could you explain it to me?

- I can’t find my company’s beta. Can you help me?

My value conclusion doesn’t make sense. Can you review it with me?

The Section 4: Valuation Conclusion paper

- Must be two to four double-spaced pages in length including any tables or calculations (but not including title and references pages) and formatted according to
*APA Style*as outlined in the Writing Center’s*APA Formatting for Microsoft Word*resource. - Must include a separate title page with the following:
- Title of paper in bold font
- Space should be between title and the rest of the information on the title page.

Student’s name

Name of institution (The University of Arizona Global Campus)

Course name and number

- Instructor’s name

Due date

- Must utilize academic voice. See the
*Academic Voice*resource for additional guidance. - Must include a separate references page that is formatted according to APA Style as outlined in the Writing Center. See the
*APA: Formatting Your References List*resource in the Writing Center for specifications.

Must cite where the financial statement information comes from (e.g., Yahoo! Finance or Mergent)

- For help citing the information from Mergent, see the BUS401: Principles of Finance Research Guide.
- What are the similarities between the time value of money formulas (from Week 3) and the NPV analysis in the Week 4 discussion?
- What is the purpose of NPV analysis? Be sure to discuss the concepts of risk and return in your answer.
- What are two improvements or corrections you could make to your previous assignments in preparation for the final project that is due in Week 5?
- What is going well and what are you struggling with in regard to Weeks 3 and 4?

What is one question you have about the Week 4 assignment or the Week 5 final project?