Financial Analysis: Corporate Investment and Valuation Assignment

This homework assignment provides a detailed analysis of corporate investments, covering various valuation models and financial metrics. The solution includes calculations and explanations for different scenarios, such as determining the P/E ratio for Lauren Entertainment, computing growth duration for different companies, and evaluating investment decisions based on P/E ratios. It identifies and explains the factors estimated in valuation models, discusses the problems associated with the dividend valuation model, and applies the constant growth dividend discount model. Furthermore, it includes plotting the SML line, calculating ROE using the DuPont formula, and determining sustainable growth rates. Finally, it discusses the implications of a sustainable growth rate exceeding the actual growth rate and potential measures the company could take. The assignment uses financial concepts and calculations to assess stock valuation and investment strategies, providing a comprehensive overview of corporate investment analysis.

Running head: CORPORATE INVESTMENT ANALYSIS
Corporate investment analysis
Name of the University:
Name of the Student:
Authors Note:

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CORPORATE INVESTMENT ANALYSIS
Table of Contents
Ch 14.6:......................................................................................................................................3
a) Depicting whether it could maintain its superior growth rate for the next 10 years:.............3
b) Depicting whether it could maintain its superior growth rate for the next 5 years:..............3
Ch 14.7:......................................................................................................................................4
a) Computing the growth duration of each company stock relative to S&P industrials:...........4
b) Compute the growth duration of company A relative to company B:...................................4
c) Depicting the investment decisions:......................................................................................4
Ch 14.8:......................................................................................................................................5
a) Identifying the three factors that is estimated for valuation model and explain these
estimates are more difficult to derive for common stock:..........................................................5
b) 1) Explaining the principles problems involved in using dividend valuation model to value
companies closely related to economic cycle:...........................................................................5
b) 2) Explaining the principles problems involved in using dividend valuation model to value
companies that are large and mature:.........................................................................................6
b) 3) Explaining the principles problems involved in using dividend valuation model to value
companies that are quite small and are growing rapidly:...........................................................6
Ch 14.10:....................................................................................................................................6
a) Depicting expected long-term total return on stock by using constant growth dividend
discount model:..........................................................................................................................6
b) Briefly discussing the three disadvantages of constant growth dividend model:..................7
c) Identifying the three alternative methods to the dividend discount model for valuation of
companies:..................................................................................................................................7
Ch 14.11:....................................................................................................................................7
a) 1) Plotting SML line for Stock A and Stock B:.....................................................................7

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CORPORATE INVESTMENT ANALYSIS
b) Depicting whether stock A and B are overvalued or undervalued if using SML method:....9
Ch 14.12:....................................................................................................................................9
a) 1) Identifying and calculating the three components of the DuPont formula:.......................9
a) 2) Calculating the ROE for 2011 using three components of the DuPont formula:............10
a) 3) Calculating the sustainable growth rate for 2011:...........................................................11
b) Assuming the calculated sustainable growth rate continuous to exceed the actual growth
rate:...........................................................................................................................................11
Reference:................................................................................................................................13

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CORPORATE INVESTMENT ANALYSIS
Ch 14.6:
a) Depicting whether it could maintain its superior growth rate for the next 10 years:
Particulars Value
Lauren Entertainment growth rate: 0.18
Market growth rate: 0.08
Market Multiple 18
Duration in years: 10
Duration in years: 5
For next 10 years P/E ratio is 43.63701
b) Depicting whether it could maintain its superior growth rate for the next 5 years:
Particulars Value
Lauren Entertainment growth rate: 0.18
Market growth rate: 0.08
Market Multiple 18
Duration in years: 10
Duration in years: 5
For next 5 years P/E ratio is 28.02617

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CORPORATE INVESTMENT ANALYSIS
Ch 14.7:
a) Computing the growth duration of each company stock relative to S&P industrials:
Particulars Company A Company B S&P
P/E ratio 30 27 18
Expected growth rate 0.18 0.15 0.07
Dividend Yield 0 0.01 0.02
Growth duration of each company relative to S&P
industrial
6.4 years 6.51 years
b) Compute the growth duration of company A relative to company B:
Particulars Company A Company B
P/E ratio 30 27
Expected growth rate 0.18 0.15
Dividend Yield 0 0.01
Growth duration of Company A relative to Company B 6.16 years
c) Depicting the investment decisions:
The overall investment decisions are mainly based on P/E ratio of the company,
which could help in growing the overall returns from investment. Therefore, investments
needs to be conducted based on the lowest P/E ratio, which allows the investment to grow
adequately.

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CORPORATE INVESTMENT ANALYSIS
Ch 14.8:
a) Identifying the three factors that is estimated for valuation model and explain these
estimates are more difficult to derive for common stock:
The three factors that are estimated for the valuation modes are depicted as follows.
Expected cash flows:
Bonds cash flow mainly consist of interest rate or the coupon payments along with the
principle payments. However, for stocks cash dividends are not expected, where future
dividends of the organisation cannot be estimated.
Length of period:
Moreover, stocks are mainly paid annually, where length of the period is not known,
as stock is mainly considered perpetual in nature. However, bonds length of the period is
mainly depicted in form of daily, monthly, annually, and semi annually coupon payments.
Required rate of return:
Both stocks and bonds required rate of return could not be estimated easily, where the
required rate of retune of bonds is mainly depicted from the risk free rate. However, the
required rate of return for stocks is mainly derived from security market line, stocks beta and
market risk premium (Damodaran, 2016).
b) 1) Explaining the principles problems involved in using dividend valuation model to
value companies closely related to economic cycle:
The companies whose operations are closely monitored by economic cycle will not be
able to provide constant dividends.

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CORPORATE INVESTMENT ANALYSIS
b) 2) Explaining the principles problems involved in using dividend valuation model to
value companies that are large and mature:
Matured companies are mainly faced with slow growth rate in dividends, where
organizations are not able to generate the required growth to support its dividend expense.
These types of companies use high payout ratio to maintain the dividend growth, which is
only conducted for a short duration.
b) 3) Explaining the principles problems involved in using dividend valuation model to
value companies that are quite small and are growing rapidly:
The company who are small and growing are not able to sustain the above average
growth rate indefinitely, which could reduce the impact of dividend valuation model.
Ch 14.10:
a) Depicting expected long-term total return on stock by using constant growth
dividend discount model:
Particulars Value
Price of stock today $20
Expected growth rate of dividends 8%
Annual dividend one year forward $0.60
Constant-growth dividend discount model (Annual dividend / Price) + growth rate)
Constant-growth dividend discount model (0.60 / 20) + 0.08)
Constant-growth dividend discount model 11%

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CORPORATE INVESTMENT ANALYSIS
b) Briefly discussing the three disadvantages of constant growth dividend model:
The three disadvantages of the constant growth dividend model is mainly, depicted as
follows.
 The growth dividend model is mainly used by small investors and not be strategic
investors at the time of buying the company
 The model is based on the that dividend are constant, which is not possible in real life
scenario
 The model mainly fails to perform when growth rate is more than required rate of
return. This only indicates that the model mainly assumes that growth rate always
needs to be less than required rate of return, which could help in deriving the adequate
growth of the shares (Reilly, 2012).
c) Identifying the three alternative methods to the dividend discount model for
valuation of companies:
The three alternative methods that are mainly used instead of divined discount model
for the valuation of the company are mainly depicted as follow.
 Discounted cash flow method
 Price earnings ratio method
 Net assets value method
Ch 14.11:
a) 1) Plotting SML line for Stock A and Stock B:

4.5%
14.5% * Stock A = 16.50%
* Stock B = 12.50%
0.8 1.2
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CORPORATE INVESTMENT ANALYSIS
Working notes
ER on Stock A Risk free rate + Beta * (Market return – Risk free rate)
ER on Stock A 4.5% + 1.2 * (14.5% – 4.5%)
ER on Stock A 4.5% + 1.2 * (10%)
ER on Stock A 4.5% + 0.12
ER on Stock A 16.50%
Working notes
ER on Stock B Risk free rate + Beta * (Market return – Risk free rate)
ER on Stock B 4.5% + 0.8 * (14.5% – 4.5%)
ER on Stock B 4.5% + 0.8 * (10%)
ER on Stock B 4.5% + 0.08
ER on Stock B 12.50%

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CORPORATE INVESTMENT ANALYSIS
b) Depicting whether stock A and B are overvalued or undervalued if using SML
method:
0 0.2 0.4 0.6 0.8 1 1.2 1.4
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
12.50%
16.50%
returns
SML line
Linear (SML line)
If the analysis use the SML method for investment then both Stock B will mainly be
used, as Stock A is overvalued, as it has higher beta than the market.
Ch 14.12:
a) 1) Identifying and calculating the three components of the DuPont formula:
The over DuPont formula mainly consist of three calculations for Return on Equity
(ROE). The formula for ROE is depicted as follows.
Particulars Value
ROE Net Income / Equity
ROE (Net Income / Sales) * (Sales / Total assets) * (Total assets / equity)
Therefore, the above table mainly represents the overall ROE formula, which could
help in identifying the overall return on investment of equity.

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CORPORATE INVESTMENT ANALYSIS
a) 2) Calculating the ROE for 2011 using three components of the DuPont formula:
Particulars Value
Equation 1 Net Income / Sales
Equation 1 510 / 5140
Equation 1 9.9%
Particulars Value
Equation 2 Sales / Total assets
Equation 2 5140 / 3100
Equation 2 1.658
Particulars Value
Equation 3 Total assets / equity
Equation 3 3100 / 2200
Equation 3 1.41
Particulars Value
ROE Net Income / Equity
ROE (Net Income / Sales) * (Sales / Total assets) * (Total assets / equity)
ROE 9.9% * 1.658 * 1.41
ROE 23.2%

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CORPORATE INVESTMENT ANALYSIS
a) 3) Calculating the sustainable growth rate for 2011:
Particulars Value
dividend payout ratio Dividend per share / Earnings per share
dividend payout ratio 0.6 / 1.96
dividend payout ratio 0.31
Particulars Value
Retention ratio 1 – dividend payout ratio
Retention ratio 1 – 0.31
Retention ratio 0.69
Particulars Value
Sustainable Growth rate ROE * Retention ratio
Sustainable Growth rate 23.2% * 0.69
Sustainable Growth rate 16.09%
b) Assuming the calculated sustainable growth rate continuous to exceed the actual
growth rate:
It is mainly depicted that if the problem of the organization is not persistent then the
management could accumulate the required resource in anticipation of future growth.
Moreover, there are four different alternatives types of measures, which could be considered
by the organisation when actual growth falls below sustainable growth are depicted as
follows.