In this cyberproblem, you will value the stock for Emerson Electric, a scientific and technical instrument company. While stock valuation is obviously important to investors, it is also vital to companies engaging in a merger or acquisition. Here, the process of stock valuation can often be quite subjective. Frequently, the opposing sides of a merger or acquisition will have vastly differing opinions of a firm’s value.
For example, part of AT&T’s purchase of McCaw Cellular called for AT&T to acquire McCaw’s 52 percent stake in LIN Broadcasting and purchase the remaining 48 percent at its fair value. LIN’s advisor’s valued the stock at $162 a share, while AT&T estimated its value at $100 a share. The difference resulted in a whopping $1.6 billion. As this example demonstrates, stock valuation seems to be both art and science.
In this cyberproblem, you will use the dividend growth model’s constant growth assumptions to value Emerson’s stock. In addition, you will apply the concepts of risk and return by estimating the stock’s ‘required return from the CAPM model. In order to arrive at a value for Emerson Electric, you will gather and use information from a variety of sources, including http://www.bloomberg.com and http://www.reuters.com.
a.First, you need to find an estimate of the risk-free rate of interest, rRF. For this cybeproblem, use www.bloomberg.com to find the 10-year Treasury bond rate, and use this interest rate as the risk-free rate. For this purpose, go to http://www.bloomberg.com then click on “Market Data” and then click on “Rates and Bonds”.
In addition, you also need a value for the market risk premium. However, rM is not directly observable. It can be estimated using index returns or consensus analyst estimates, but may not be entirely accurate. However, studies indicate that historically, the market risk premium ranges from 4% to 8%. For this cyberproblem, we will use an assumed market risk premium of 7.0%.
10-YEAR Treasury bond rate = 1.78%
b.Find an estimate of Emerson Electric’s beta using Reuters’ website, found at http://www.reuters.com. Use Reuters’ stock symbol lookup function to get Emerson’s stock symbol. When you are on Emerson Electric’s page then look for the company’s beta.
BETA = 1.15
c.From data gathered in Parts a and b, use the CAPM model to determine Emerson’s required return.
ks = kRF + ß(kM –kRF) = 1.78% + 1.15(7%) = 9.8%
d.Identify Emerson’s current annual dividend and 5-year dividend growth rate. Use Reuters to go to Emerson Electric’s page then choose “Stocks: Financial Highlights” to find this information.
e.The fundamental valuation of any financial asset is the present value of all its anticipated future cash flows. For this reason, the current dividend does not interest us as much as the next annual dividend does. Calculate Emerson’s next expected annual dividend, D1.
f.Assuming the constant growth rate, use the Time Value of Money model, i.e., the Discounted Cash Flow model, to determine the expected price of one share of Emerson Electric stock.
g.Compare Emerson’s expected value with its current market price. You can use Reuters to obtain Emerson’s current stock quote.