University : | RMIT University UniLearnO is not sponsored or endorsed by this college or university. |
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Subject Code : | BAFI1042 |
The assessment is submitted as a group assignment
You are required to analyse Fortescue Metals Group Limited (FMG.AX) and prepare an investment recommendation report. The report provides an assessment of the company's current position and future prospects, incorporating the use of various valuation techniques to arrive at estimates of the intrinsic value of the company's shares.
Your report should make a case for the company's shares to be rated in one of the following ways:
Evaluate the relative historical financial performance of the company among its peers • identify the firm's competitors and discuss why they have been selected • identify, and explain the relevance of, five financial ratios of your choice (not to
include ROE, Net Profit Margin, Total Asset Turnover or Financial Leverage) for the company and its peers (potential ratios to include Return on Assets, NPAT, Debt to Equity, Gross Margin, Operating Leverage, EPS Growth, Interest Cover Ratio)
• explain the performance of the company compared to its peers using this analysis ???? analyse and explain the reasons for changes in these ratios over the past five years and compared to the average of the past five years
???? do not simply describe the changes in the ratios
Estimate the ROE of the company for the most recent five years using the DuPont ROE approach.
• DuPont Analysis should be done using the 3-step procedure
• 3 steps: Net Profit Margin, Total Asset Turnover and Financial Leverage • analyse the company's and your selected peer companies' ROEs over the period • show your own calculations for each component over the previous five years • compare the DuPont ROE of the company with its industry peer group companies ???? analyse and comment on the reasons for the change in ROE for the firm and its
competitors with reference to the difference in the three components over five years ???? relevant charts/graphs may be used to illustrate these figures
Analyse the company' s/industry's current issues and explain the effect of these issues on the company's future earnings
a) At the Macroeconomic Level
• general factors that apply for the industry (GDP, employment, growth of the industry, regulation, global factors, supply, demand, world commodity prices, etc.)
b) At the Microeconomic Level
• the company- and industry-specific factors (operation, financials, objectives, competition, etc.)
c) As a SWOT analysis
• detail the Strengths, Weaknesses, Opportunities and Threats to the company d) As either a PESTEL or a Porter analysis
• analyse the company's position in its industry using one of the above techniques
Intrinsic Value Estimation
Start your valuation analysis with the estimation of expected return using CAPM You need 3 inputs to calculate the CAPM expected return
1. An Estimate of the company's Beta
Use the closing price data of the company and the market index to calculate daily returns for the most recent five years. Using this data, you can estimate raw beta by using regression analysis. Attach details of your work as an Appendix.
???? Adjust the Raw Beta using the formula: Adjusted Beta = (0.67) x Raw Beta + 0.33
2. The Risk-Free Rate of Return
Use the 10-year Australian Government bond yield as a proxy for the RFR. This yield can be found on Eikon page AU10YT=RR.
3. The Market Return
It is the difference between expected market return E(Rm) and the RFR Please use this estimate of the market return E(Rm): 9.85% (Source: Bloomberg)
???? The estimated CAPM required return should be used as the discount rate in your valuation models
Estimate the intrinsic value of the company's shares using the dividend discount model (DDM)
• you must use a 3 Stage DDM. Follow the methodology discussed in Equity Valuation Chapter
• use CAPM return as your discount rate
• determine the growth rate for Period 1 using the average growth rate in dividends for the past 5 years
• estimate the growth rate for Period 2 using your discussion in the company's/industry current issues section
• estimate the terminal (Period 3) growth rate using a proxy that represents the long term growth rate and calculate the terminal value
• calculate the present value of each future dividend and the terminal value, then add them to calculate the intrinsic value of the company
???? provide justification and reasoning if you use a different growth rate than the one calculated for Period 1
???? provide justification and reasoning for your growth rate assumptions for growth in Period 2 and Period 3
Estimate the intrinsic value of the company's shares using the Free Cash Flow to Equity (FCFE) model
• you must use a 3 stage FCFE model to calculate the intrinsic value of the stock
• source the components for FCFE from the company's financial statements using Eikon
• calculate the FCFE per share over the past six years. The average growth in FCFE per share will be the growth rate for Period 1
Formula - FCFE = Net Income + (Depreciation Expense – Capital Expenditures) - ? in Working Capital - Principal Debt Repayments + New Debt Issues
• estimate the growth of FCFE for Period 2 using your macro and microanalysis • estimate the terminal (Period 3) growth rate using a proxy that represents the long term growth rate and calculate the terminal value
• calculate the present value of each future year's FCFE to calculate present value, then add them to calculate the intrinsic value of the company
???? provide justification and reasoning if you use a different growth rate than the one calculated for Period 1
???? provide justification and reasoning for your growth rate assumptions for growth in Period 2 and Period 3
Apply Relative Valuation techniques to ascertain the valuation of the firm
• calculate and compare multiples such as Price-to-Book, Price-to-Earnings and Price-to-Cash Flow or Price-to-Sales for the company and its peers
• determine the relative valuation of the firm using these multiples (do not attempt to calculate the share price)
???? analyse and comment on the relative valuation of the firm in comparison to its peers
Using relevant charts, evaluate the company's share price performance over the last five years
• compare the relative performance of the company to the broad market index • compare the relative performance of the company to its peer group ???? comment on these charts, referencing reasons for any significant changes you have identified
Perform a technical analysis of share price movements over the last five years
• use 50-day vs 200-day moving average lines and volume analysis to identify Buy/Sell/Hold signals
???? show, and comment on, these analyses with reference to charts sourced from Eikon
Evaluate your findings
• Why do the intrinsic values you have calculated differ from the current/recent share price?
• How does this difference inform your investment recommendation? • Why is there a difference between your DDM valuation and the one from the FCFE valuation?
• Which is the most appropriate valuation model for this company? Why? • And, more importantly, what is your investment decision based on your evaluation?
• Is your recommendation to Buy, Sell or Hold shares in this company? • Is it different from the signal obtained from the technical analysis? Why? • Does your qualitative analysis agree with your quantitative analysis? If not, why not?
Important points to be covered regarding Valuation Models
• Explain any assumptions you have made in implementing your models. • Where appropriate, explain how you arrived at the variables you are using. For example, it is not enough to say you are assuming a 2% growth rate. You will be expected to provide justification for your 2% growth rate.
• Provide tables of data for FCFE calculations.
• It's not enough to simply describe the financial ratios. You must find reasons why they are changing, especially if there are significant changes year-to-year. This will require in-depth research.
• You must use Refinitiv Eikon Online and IBISWorld as major data sources. Presentation of Report
The report is to be presented in the form of a stock analyst's investment report. It should have an Executive Summary, outlining the main findings, at the beginning. The remainder can be structured in line with the above points. Attach details of your working and calculations, and any other relevant information, as an Appendix. DO NOT send a separate Excel file. Don't include all the data for the beta calculation, just the regression statistics from Excel.
• Illustrate your arguments with relevant charts and diagrams.
• Relate all the information in your analysis to your investment recommendation. • Build a case for your recommendation by using your findings from each of the points above.
• Your report should look professional.
• DO NOT attach information you have used in compiling the report (annual reports, newspaper articles, etc.) to the report.
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