Finance
Securities Analysis
Company: General Motors Company
Market and Industry Analysis Assignment (10-12 pages)
Purpose of this research paper is to describe the current economic environment in the US stock market and your industry. Based on your analysis, you should project possible prospects of the market and the industry in the coming year, analyze the factors that affect the environment. Specifically, you should provide following detailed information in your analysis:
A. Company profile (The company is General Motors). You should choose a company with a tractable record at least five years. The company’s accounting and market information should be available for your study. Your report should include the description on size and lines of business, brief history of the company, its position in the industry, and some major changes in recent years.
B. Brief statement on one year economic and political outlook in US regarding GDP, inflation, employment, interest rates, export and import. How does it impact on your company’s performance?
C. Discuss your industry in terms of its industrial life cycle. Discuss industry problems and opportunities for the coming year. You can also discuss specifically the relationship between your industry and whole economy, such as business-cycle sensitivity.
Tips:
· Organize your paper with section/subsection titles.
· Look up your data, figures/tables from theses websites: Mergent.com, Value Line, Dow Jones factiva, Yahoo Finance, Business Insight Global, IBISWorld, SCC.gov
· Include figures/tables if needed.
· Cite your sources where it is necessary in the text.
· Provide a complete list of references
Financial Statement Analysis ( 4-5 pages )
Purpose of this section of the paper is to analyze some important financial ratios for the company based on its past performance in order to make a reasonable assessment about its future prospect. Also this analysis sets a base on your investment decision in the future assignments.
A. You should comment on the major changes you observe over five (5) years of balance sheets, income statements, and cash-flow statements. If you have explanations to support these major changes, provide them.
B. Using the same five (5) year statements, you should provide a complete DuPont Analysis. (as enclosed in the Textbook) Out of DuPont model, you should comment on the following aspects of your company:
Operating efficiency (total assets turnover) Operating profitability (profit margin, earning per share) Financial risk (leverage ratio) Growth potential (retention rate, return on equity)
All ratios should be analyzed regarding their trend over five (5) years as well as compared to the industry’s standard. You may use ratios of your competitor or the leading company in the industry as the proxy for the industry’s standard.
C. The conclusion should report what you expect the company to do for the next year in order to maintain its leading position, or improve some aspects that seem below the industry average.
D. Using financial statements, you should calculate following market ratios for your firm for last five years.
P/E ratio P/Cash Flow ratio P/Book ratio P/Sales ratio
Do not forget to cite your sources where it is necessary. Do not forget to provide in appendices:
• five (5) year of balance sheets, income statements neatly presented • the values for all ratios and industry’s values for comparison (tables and graphs)
Free Cash Flow Analysis ( 4-5 pages )
Purpose of this section of the paper is to forecast and analyze your firm’s FCFF or FCFE. The majority of the information necessary to compute cash flows comes from either the reported financial statements or the Value Line report.
A. Set the Time Frame of the Forecast. Be realistic in selecting the detailed analysis time frame. For a large established company, a 10-year forecast may make sense. You may divide the time frame into three stages: the immediate future stage (e.g. 5 years), the transitional stage (e.g. 5 years), and the mature stage (after that).
B. Determine the time period of the detailed forecast for which good estimates are possible and of the simplified forecast for the more distant future.
C. Perform the detailed forecast for the near future stage, where good estimates are possible. You can use following formula and make some comments if necessary: FCFF= EBIT x (1 - TaxRate) + Depreciation – CAPX – Increase in NWC FCFE = FCFF –Interest x (1-TaxRate) + Increases in net Debt
You can either use the ValueLine approach (recommended) or the Sale-based approach.
D. Important inputs to discuss/think about:
· Are your margin projections increasing/decreasing/constant?
· Is investment in capital expenditures increasing or decreasing?
· Is depreciation & amortization increasing or decreasing?
· Does the change to Working Capital make sense?
· What is your tax rate?
Do not forget to cite your sources where it is necessary. Do not forget to provide your Excel template.
Systematic Risk and CAPM ( 4-5 pages )
Purpose of this section of the paper is to calculate the systematic risk (β) of your company, and therefore to estimate the required rate of return (k) using CAPM.
A. The calculation should rely on at least 60 monthly (or 250 weekly) returns on your company’s stock and on the market (S&P 500 Index, for example). A regression line should be built on Excel and a graph of the characteristic line (SCL) should be provided. A short interpretation on β value and characteristic line should be given too.
B. You should build your own security market line (SML). Explain your calculation for the annual risk free rate and the annual market return. The required return (k) should be visible on the graph and its value should be supported by calculation.
Do not forget to provide:
· The table showing prices and returns you use to calculate β and to build the characteristic line (in appendices)
· A graph showing characteristic line and β
· A graph showing the SML, the risk free rate, the market return, and your company required return k.
Valuation Assignment ( 4-5 pages )
Purpose of this section of the paper is to estimate value of your company’s stock by the FCFF and FCFE methods. Then comparing the market price, you make a recommendation.
A. The Beta from your regression in Assignment #4 is only a preliminary estimate. You need to compare it with the Beta from other reports, and make adjustments if necessary.
B. Re-calculate the required rate of return (kcs) based on the new Beta. Don’t forget we already got risk-free rate and expected market return in HW#4. Be sure to use your values to replace those in the template.
C. Calculate the weighted average cost of capital (WACC). If your company has preferred shares,
WACC = wd[kd(1-t)] + wpskps + wcskcs
Where wd, wps, wcs are the percentage weights of debt, preferred stock and common stock in the capital structure. kd, kps, kcs are costs of debt, preferred stock and common stock. t is tax rate.
If your company has no preferred shares, WACC = wd[kd(1-t)] + wcskcs
Cost of debt can be estimated as interest rate paid on debt. Cost of preferred stock can be estimated as kps = Dps/Pps, where Dps is the dividend per preferred share, and Pps is the market price per preferred share. If your company does not offer preferred shares, set wps to zero.
Note: You can assume the cost of common stock (kcs) to remain the same if the company’s capital structure (debt/equity) remains stable. Otherwise, you will forecast debt/equity and then deleverage beta and releverage beta to calculate cost of common stock for each year. (These are built into the Excel template)
D. Now that we have all discount rates available. The next steps are to get FCFFs or FCFEs in the future. We already have free cash flows projected for immediate stage (next 5 years) from HW#3. Next, assume the growth rate of FCFF at the beginning of the transitional is equal to the immediate stage average. Then you decide the growth rates at the end of the transitional stage (the terminal growth rate). Finally you use the linear interpolation to set annual growth rates for the rest of years in the transitional stage so you have a gradual and smooth declining growth rate towards the maturity. Based on your growth rate assumptions of FCFF or FCFE, forecast the cash flows.
E. Estimate the terminal firm value (if using FCFF) or terminal equity value (if using FCFE) by using the constant growth model. The FCFFs are discounted by the WACC, while the FCFEs are discounted by kcs.
E. Once the intrinsic value of firm is estimated, you subtract value of Debt (and value of preferred stock if any) to get the total value of common equity. After dividing total outstanding shares from the total value of common equity, you will get the value per share. Similarly, if you use FCFE approach, you discount future FCFEs at the cost of equity kcs, and sum them up to get the total value of common equity. After dividing total outstanding shares, you will get the value per share.
F. Use the Excel free cash flow template (either sales based approach or valueline approach) to complete your work. Discuss your estimates from FCFF model, and make any adjustments if necessary, and reach your conclusions with current stock price. Based upon your result, what recommendation you will make for this stock?
Do not forget to provide in appendices:
· The Value Line report or your estimation process of FCFF and FCFE
· The Excel tables showing future cash flows you use to calculate
· Other reference and reports you used for your analysis