24May

BUMN044H7 Valuation Analysis and Risk Management Assignment Help

BUMN044H7 Valuation Analysis and Risk Management

PART I: NextEra Energy Inc. STOCK VALUATION (75 marks)

As a new analyst for a large brokerage firm, you are anxious to demonstrate the skills you learned in your MSc programme and prove that you are worth your attractive salary. Your first assignment is to analyse the NextEra stock. Your boss recommends determining prices based on both the dividend-discount model and discounted free cash flow valuation methods. NextEra uses a cost of equity of 7.5% and an after-tax weighted cost of capital of 6.5%. It expects 3% return on new investments. However, you are a little concerned because your finance professor has told you that these two valuation approaches can result in widely differing estimates when applied to real data. You are really hoping that these alternative valuation methods will reach similar prices.

  1. Go to Yahoo! Finance (http://finance.yahoo.com) and enter the symbol for NextEra (NEE). From the main page for NEE, gather the following information and enter it into an Excel spreadsheet:
    1. The current stock price (last trade).
    1. The current dividend amount.
  • From the “Key Statistics” page, gather the following information and enter it on the same spreadsheet:
    • The number of shares of stock outstanding.
    • The payout ratio.
  • From the “Analyst Estimates” page, find the expected growth rate for the next five years and enter it onto to spreadsheet.
  • Start Excel, create a new blank spreadsheet and select Data / From Web. In the New Web Query box, paste the URL for NextEra’s “Income Statement” of the web page and press return. Use the little yellow and black arrow boxes to select the table containing the entire three years of income statements and import them. Repeat this process for both the balance sheet and cash flow statements for NextEra. Keep all the different statements in the same Excel worksheet.
  • To determine the stock value based on the dividend-discount model:
    • Create a timeline in Excel for five years.
    • Use the dividend obtained from Yahoo! Finance as the current dividend to forecast the next five annual dividends based on the five-year growth ratio.
    • Determine the long-term growth rate based on NextEra’s payout ratio (Eq. 9.12).
    • Use the long-term growth rate to determine the stock price for year five (Eq. 9.13).
    • Determine the current stock price based on the dividend-discount model (Eq. 9.14).
  • To determine the stock value based on the discounted free cash flow method:
    • Forecast the free cash flows using the historical data from the financial statements downloaded from Yahoo!Finance, Bloomberg or Capital IQ to compute the three-year average of the following ratios:
      • EBIT/Sales and NI/Sales
      • Tax Rate
      • Property Plant and Equipment/Sales and Depreciation/Property Plant and Equipment
      • Net Operating Working Capital/Sales
      • Net Borrowing/Sales
    • Create a timeline for the next seven years.
    • Forecast future sales based on the first five years and the long-term growth rate for years 6-7.
    • Use the average ratios computed in part (a) to forecast EBIT, property, plant and equipment, depreciation, and net working capital for the next seven years.
    • Forecast the free cash flow for the next seven years (Eq. 9.18).
    • Determine the horizon enterprise value for year 5 (Eq. 9.24).
    • Determine the enterprise value of the firm as the present value of the free cash flows.
    • Determine the stock price based on discounted free cash flow methods (FCFF and FCFE).
  • Compare the stock prices from these methods to the actual stock price. What recommendations can you make as to whether clients should buy or sell the stock based on your price estimates?
  • Explain why the estimates from these valuation methods differ 1) from the market price and 2) between themselves. Specifically, address the assumptions implicit in the models themselves as well as those you made in preparing your analysis. Why do these estimates differ from the actual stock price of NextEra?

PART II: NextEra OPTION VALUATION (25 marks)

Using the CBOE option table for NextEra, compare the market price at market close on April 4, 2023 for the (a) April, (b) June, and (c) September 2023 monthly call and put options with a strike price of $77.5 (≈ at- the money) to the price predicted by the Black-Scholes formula. Recent Treasury bill rates and historical dividend data are provided below. Discuss your results and limitations of the Black-Scholes option valuation model. Historical volatility for NextEra’s stock can be derived from historical daily prices (adj. close) for the last twelve months. Calculate 50-day rolling standard deviations of daily price changes and adjust the average by √𝑛 (where n is the number of trading days per year) for an estimate of annual volatility. Compute and compare the implied volatilities of options (output) with historical stock price volatility estimates (input). Determine what volatility estimate to use in the B-S option valuation model.

Use the Standard Normal Distribution Table in Appendix to determine N(d). Alternatively, you may use the Excel function NORMDIST (d,0,1,true).

Daily Treasury Yield Curve Rates (4 April 2023)

Date1 Mo3 Mo6 Mo1 Yr
4-Apr-20234.664.884.804.50
3-Apr-20234.704.904.884.60
31-Mar-20234.744.854.944.64
30-Mar-20234.744.974.924.63
29-Mar-20234.344.804.924.59
28-Mar-20234.244.804.904.55
27-Mar-20234.224.914.864.51
26-Mar-20234.284.744.764.32
25-Mar-20234.264.734.804.38

For further detail see following link: https://www.treasury.gov/resource-center/data-chart-center/interest- rates/Pages/TextView.aspx?data=yield

During the past 13 years, the highest Dividend Yield of NextEra Energy was 3.57%. The lowest was 1.65%. During the past 13 years, the highest 3-Year average Dividends Per Share Growth Rate of NextEra Energy was 13.00% per year. he forward annual dividend yield on April 4, is 2.44%. Quarterly dividends for the last four years are tabulated below.

NEE Dividend History

(Payouts are split-adjusted)

  Cash AmountDeclare DateEx-Dividend Date  Record Date  Payment DatePayout Frequency
$0.4675n.a11/22/2023n.an.aQuarter
$0.4675n.a08/28/2023n.an.aQuarter
$0.4676n.a05/26/2023n.an.aQuarter
$0.467502/17/202302/27/202302/28/202303/15/2023Quarter
$0.42510/14/202211/23/202211/25/202212/15/2022Quarter
$0.42507/29/202208/29/202208/30/202209/15/2022Quarter
$0.42505/19/202205/27/202205/31/202206/15/2022Quarter
$0.42502/18/202202/28/202203/01/202203/15/2022Quarter
$0.385 11/24/202111/26/202112/15/2021Quarter
$0.385 08/26/202108/27/202109/15/2021Quarter
$0.38505/20/202106/01/202106/02/202106/15/2021Quarter
$0.38502/12/202102/25/202102/26/202103/15/2021Quarter
$0.3510/16/202011/25/202011/27/202012/15/2020Quarter
$1.4007/30/202008/27/202008/28/202009/15/2020Quarter
$1.4005/21/202006/01/202006/02/202006/15/2020Quarter
$1.4002/14/202002/27/202002/28/202003/16/2020Quarter

For further detail on NEE dividend data go to the following link: www.nasdaq.com

APPENDIX

Black-Scholes Option Pricing Formula

The basic Black–Scholes formula calculates the price of European call and put options on an underlying stock but it can also be used to approximate the price of American stock options. The value of a call or put option for a non-dividend paying underlying stock in terms of the Black–Scholes parameters is:

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