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ACCT867 Finance for Accountants
Individual Assignment
Weighting: 30% (20% for Written Assignment and 10% for Oral Presentation)
Type: Individual assignment
Length: Maximum 2,000 words (excluding tables, graphs, references, and
Appendix) for Written Assignment
Approximately 10 minutes for Oral Presentation
Submission: It requires submitting an electronic copy of the Written Assignment
via Turnitin and submitting the Oral Presentation recording via
Panopto Video.
Requirements: The specific question(s) for this assignment will be posted on Canvas
in the Assignment folder. This assignment will cover topics introduced
in Weeks 1-5.
This assessment must follow the academic integrity guidelines stated
in the Business Programmes Assessment and Study Handbook or the
Law Programmes Assessment and Study Handbook and use the
required referencing style.
Compulsory: This assessment event is compulsory.
Programme
Learning Goals:
Learning Goal 2: Be effective thinkers and problem-solvers
Learning Goal 3: Be effective communicators (written and oral)
Learning Goal 4: Be able to apply accounting knowledge to issues in
professional accounting practice
Paper Learning
Outcomes:
1. Calculate and critically apply financial evaluation techniques to
capital investment decisions within the current financial market
environment.
3. Critically evaluate the principles and processes involved in various
sources of debt and equity finance alternatives.
4. Critically evaluate the developments in the valuation of capital
market returns (CAPM and WACC) and the capital structure decisions.
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DESCRIPTION – WRITTEN ASSIGNMENT
PART A Equity Valuation
This individual assignment is designed to apply the techniques that you learned in class on the
equity valuation of companies in today’s stock markets.
Step 1: Pick the companies and intrinsic valuation
Using Yahoo Finance or NZX Research for company search. Pick two companies, making sure
at least you have:
(Company 1, the main Company that you analyse) One Company that has growth
potential. Look for companies whose earnings or revenues have grown in recent
financial years.
(Company 2) The other Company should be the competitor of Company 1, which
means that Company 2 has a similar capitalisation and business line to Company 1 or
is in competition with the business of Company 1 for market share.
Provide a narrative regarding the purpose of this report and introduce/brief necessary details
of Company 1 you choose (e.g., how your Company was evolving; describing the
product/service markets, industries, and the competition it faces; discussing the past three-
year financial performance evident in some key financial ratios). Also, you must: 1) justify the
validity of your companies’ comparison; 2) tie your narrative to key numbers and conclusion
in your valuation. (20%)
Step 2: Discounted Cashflow Valuation
Value the stock in Company 1 using a Free Cash Flows to Equity model (you need to decide
the specifications of FCFE model that best fit your companies, e.g., 2-stage, 3-stage, or n-
stage…etc.) and provide your responses to the requirements as follows.
a) Justify the specifications of the FCFE model for your companies (i.e. what pattern (2-
stage, 3-stage, or n-stage) will you assume the Company’s growth to follow and
why?). (10%)
b) Conduct firm valuation using the FCFE Model for Company 1 (besides descriptions,
please provide all your calculations/workings in tables and graphs as possible). See the
Steps below.
(10%)
c) Identify at least two assumptions used in your discounted cash flow valuation and
describe their economic meanings. (5%)
d) Provide additional analyses and explain how the assumptions identified in (c) affect
the results of your valuations. (20%)
e) Conduct Discounted Cashflow Valuation for Company 2 and compare the results in
valuation for Company 1 with those for Company 2. (5%)
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Steps Using FCFE Valuation Model:
1. Estimate the discount rate r used in the equity valuation, that is, the cost of equity.
Please follow the instructions of PART B to calculate it.
2. Estimate the current free cash flows to equity investors (FCFE) (see Week 2 Lecture
slides)
3. Estimate the future earnings and cash flows of the firm being valued, generally by
estimating an expected growth rate in earnings (1) based on analysts’ long-term
growth forecasts (i.e. forecasted 5-year growth rate in EPS).
4. Estimate when the firm will reach “stable growth” and what characteristics (risk & cash
flow) it will have when it does. In other words, determine the growth period(s), growth
rate (2 3 ), and terminal value.
5. Use the DCF model you choose to estimate the PV of future FCFEs.
6. Compare the value relative to the market capitalisation (= stock price x number of
outstanding shares) to estimate whether the equity value of the Company is currently
overvalued or undervalued.
Calculating Free Cash flow to Equity (FCFE):
For the firm’s leverage to be stable (i.e. the net capital expenditure assumption), we
use the following:
Free Cash flow to Equity (FCFE) = Net Income - (1- DR) (Capital Expenditures
- Depreciation) - (1- DR) Working Capital Needs; where DR = Debt/Capital
Ratio or TL/TE Ratio
Step 3: Final Value Estimate and Recommendation
Consider the results obtained from the discounted cash flow and the comparable.
Provide the economic implications of your comparisons from Step 2. Make final
recommendations on the stocks of your Companies 1 and 2 (Strong Buy, Buy, Hold, Sell,
or Strong Sell), justify your recommendations, and summarise all your analyses and the
results with a conclusion. (15%)
PART B Cost of Equity
Required (please show all your workings of OLS regression analysis and simulations)
The Capital Asset Pricing Model (CAPM) is one of the most tested models in Finance. When
beta is estimated in practice, a variation of CAPM called the market model is often used. To
derive the market model, we start with the CAPM:
E() = + [() ? ]
Since CAPM is an equation, we can subtract the risk-free rate from both sides, which gives us:
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E() ? = [() ? ]
This equation is deterministic, that is, exact. In regression, we know that there is some
indeterminate error. We need to formally recognise this in the equation by adding epsilon (),
which represents this error:
E() ? = [() ? ] +
Finally, think of the above equation in a regression. Since there is no intercept in the equation,
the intercept is zero. However, when we estimate the regression equation, we can add an
intercept term, which we will call alpha:
E() ? = + [() ? ] +
This equation, known as the market model, is generally the model used for estimating beta
(). The intercept term is known as Jensen’s alpha and represents the excess return. If CAPM
holds exactly, this intercept should be zero. If you think of alpha in terms of the SML, if the
alpha is positive, the stock plots above the SML and if the alpha is negative, the stock plots
below the SML.