MPF753/953: Assignment 2, T2 2011 Due Date: Monday 5 September 2011 What is required:

In this assignment you are required to evaluate the theoretical prices of the shares of five companies that are; 1) currently traded on the Australian stock market, 2) have been in operation for seven years, 3) and have been paying dividends. Each of your chosen companies: 4) must come from a distinct industrial sector e.g. Banking and Finance, Mining and Manufacturing, Retail, Tourism & Hospitality and Transport, etc. No two companies should be chosen from the same sector. You are required to apply two distinct approaches to estimate the value of these shares and then write up a reconciliation report explaining any observed differences between the traded stock prices and the estimated values.

Approach I: Dividend Discount Model

Having selected your five companies, you will then need to download the past seven years of dividend payment history. If one of your chosen companies has paid dividends twice in a year (interim and final) then the aggregate dividend paid for the year must be obtained. If interim dividends have been considered then they have to be appropriately annualized. Using the past dividend information you will then compute a dividend growth rate applying an appropriate estimation technique. This growth rate is to will be used as a proxy for the constant growth rate in the Dividend Discount Model(the underlying theory will be covered in Week 2/3 lectures). How you estimate the growth rate is your choice. You must however clearly explain and justified whatever estimation technique you adopt. For example, you may want to try out the = FORECAST ( ... ) function in MS Excel in order to compute the next periods dividend from the last seven years dividend payout history for each of your chosen companies. Then the proxy constant growth rate term is (Next periods dividend Current dividend)/Current dividend. However this is only a suggestion you are strongly encouraged to explore other methods for estimating the growth rate. You must justify your estimation procedure for the growth rate. You will also need to apply a comparative earnings methodology to determine the cost of equity another key input variable that is needed within the Dividend Discount Model (DDM). Youll need to collate five sample sets (each sample set containing around ten different companies) from the same or a very closely related sector corresponding to each of the five companies whose stocks are being valued. After collating these sets, you will need to obtain the most recent available financial information for each of these companies in the five sets. The best way to do this is to visit the websites of each of those companies and look up their published financial statements. You can also access company financial data from FinAnalysis, which can be accessed from the Deakin Library. Using the published financial statements information, you will then need to calculate the returns on equity (ROE) of each of these companies as a percentage equal to the reported net earnings after tax (following preference stock dividends but prior to ordinary stock dividends) divided by the total shareholders equity. An arithmetic average of these ROEs in each set will yield a reasonable estimate of the required cost of equity that can then be used within the DDM in order to calculate the theoretical share prices.

! Approach II: Valuation Multiple

Under this approach, the average price-earnings ratio needs to be calculated for each of the five sample sets (corresponding to the five different sectors). The price-earnings ratio is calculated by dividing the stock price with the earnings-per-share. The earnings-per-share is calculated by dividing the net earnings figure as per the financial statements by number of shares outstanding. You should then obtain an estimate for next periods earnings-per-share for each of your chosen companies by multiplying the current years earnings-per-share figure with one plus the proxy constant growth rate term that was calculated in Approach I. Then the share price of each of the chosen five shares is estimated by multiplying the expected earnings-per-share for the next period with the average price-earnings ratio of the relevant sector. This provides an alternative estimate of the share prices that you need to compare & contrast with the DDM prices that you obtained with Approach I.

What you need to submit:

A written report limited to a maximum of 2000 words (excluding tables, figures and references) that clearly explains your procedure for estimating both of the valuation approaches. This must include a description and and justification of your estimation technique that you used to obtain the proxy constant growth rate. You must also state all your assumptions. Your report should be in MS Word format (Times New Roman font size 12, single-spaced). Any figures and tables should be clearly labelled and embedded within the body of the report as MS Excel objects DO NOT SUBMIT SEPARATE EXCEL FILES. You must include a comprehensive list of references for both your data sources as well as citations. You are permitted to use any standard academic referencing style but you must be consistent.

How you will be assessed:

This assessment is worth a total of 20 marks. You will need to include in your write-up: (1) The names and last seven years dividend payout data of the five companies whose stocks you chose to evaluate (2 marks). [Remember to cite all sources for your data] (2) Full details (including logical justification) of the estimation method used to compute the proxy value for the constant growth rate term (6 marks). (3) Full names and latest reported net earnings of all the companies from the same or a closely related sector in your sample sets that you collate for the purpose of establishing a reasonable cost of equity for each one of your chosen five companies (2 marks). [Remember to cite all sources for your data] (4) The calculation of the individual ROEs for the companies in the sample sets plus the calculation of the estimated cost of equity as the arithmetic average of the individual ROEs for the companies in the sample sets for each of your chosen five companies (2 marks). (5) The calculation of average price-earnings ratio, earnings-per-share, expected earningsper-share and estimated share price applying the valuation multiple approach for each of your chosen five companies (4 marks). [Remember to cite all sources for your data] (6) A reconciliation report comparing & contrasting the theoretical share prices obtained using the two different approaches as well as the actual market price for each of your five chosen companies and providing an explanation for any observed differences (4 marks).

---------------------------------------------------------------------------------------------------------------Useful online resources: http://au.finance.yahoo.com http://www.asx.com.au/asx/markets/dividends.do http://efinance.org.cn/cn/fm/The%20Dividend%20Discount%20Model%20A%20Primer.pdf