As a new junior analyst for a large brokerage firm, you are anxious to demonstra

Question

As a new junior analyst for a large brokerage firm, you are anxious to demonstrate the skills you learned in college and prove that you are worth your attractive salary. Your first assignment is to analyze the stock of General Electric Corporation. Your boss recommends determining prices based on both the discounted free cash flow valuation method and the comparable P/E ratio method. You are a little concerned about your boss's recommendation because your finance professor has told you these two valuation methods can result in widely differing estimates when applied to read data. You are really hoping the two methods will reach similar prices.

1. Go to Yahoo! Finance (http://finance.yahoo.com) and enter the symbol for General Electric (GE). From the main page for GE, gather the following information and enter it into a spreadsheet:

a) The current stock price (last trade) at the top of the page.

b) The EPS (ttm).

2. Click on "Key Statistics" at the left side of the page. From the Key Statistics page, find the number of shares of stock outstanding and enter it into the spreadsheet.

3. Click on "Analyst Estimates" at the left side of the page. On the Analyst Estimates page, find the expected growth rate for the next five years and enter it into your spreadsheet. It will be near the very bottom of the page.

4. Click on "Competitors" at the left side of the page. The industry average P/E ratio is in the far right column, marked "Industry". Copy it into your spreadsheet.

5. Click on "Income Statement" near the bottom of the menu on the left. Copy and paste the entire three years' worth of income statements into a new worksheet in your existing Excel file. Repeat this process for both the balance sheet and the cash flow statement for GE. Keep all of the different statements in the same Excel worksheet.

6. To determine the stock value based on the discounted free cash flow method:

a) Forecast the free cash flows using the historic data from the financial statements downloaded from Yahoo! Finance to compute the three-year average of the following ratios:

i. EBIT/Sales

ii. Tax rate (income tax expense/income before taxes)

iii. Property, plant and equipment/sales

iv. Depreciation/property, plant, and equipment

v. Net Working Capital/Sales

b) Create an empty timeline for the next five years.

c) Forecast future sales based on the most recent year's total revenue growing at the five-year growth rate from Yahoo! Finance for the first five years.

d)Use the average ratios computed in part (a) to forecast EBIT, property, plant, and equipment, depreciation, and net working capital for the next five years.

e) Forecast the free cash flow for the next five years.

f) Determine the horizon enterprise value for year 5 and a long-run growth rate of 4% and a cost of capital for GE of 11%.

g) Determine the enterprise value of the firm as the present value of the free cash flows.

h) Determine the stock price. Note that your enterprise value is in $ thousands and the number of shares outstanding is in billions.

7. To calculate an estimate of GE's prices based on a comparable P/E ratio, mulitply the industy average P/E ratio by GE's EPS.

8. Compare the stock prices produced by the two methods to the actual stock price. What recommendations can you make as to whether clients should buy or sell GE's stock based on your price estimates?

9. Explain to your boss why the estimates from the two valuation methods differ. Specifically address the assumptions implicit in the models themselves as well as the assumptions you made in preparting your analysis. Why do these estimates differ from the actual stock price of GE?

Explanation / Answer

Answer-1 Current stock price of GE = $30.83 Earning per share = ($0.73) Answer-2 Number of shares outstanding = 9.44 billion Answer-3 Growth rate for next five years = 7.50% Answer-4 Industry P/E = 18.75 Answer-5 Period Ending 31-Dec-14 31-Dec-13 31-Dec-12 Total Revenue 148,589,000   146,045,000   146,684,000   Cost of Revenue 83,859,000   79,817,000   77,167,000   Gross Profit 64,730,000   66,228,000   69,517,000   Operating Expenses Research Development - - - Selling General and Administrative 34,026,000   35,143,000   35,897,000   Non Recurring 3,993,000   4,818,000   3,832,000   Others - - - Total Operating Expenses - - - Operating Income or Loss 26,711,000   26,267,000   29,788,000   Income from Continuing Operations Total Other Income/Expenses Net - - - Earnings Before Interest And Taxes 26,711,000   26,267,000   29,788,000   Interest Expense 9,482,000   10,116,000   12,407,000   Income Before Tax 17,229,000   16,151,000   17,381,000   Income Tax Expense 1,772,000   676,000   2,534,000   Minority Interest -112,000 -298,000 -223,000 Net Income From Continuing Ops 15,457,000   15,475,000   14,847,000   Non-recurring Events Discontinued Operations -112,000 -2,120,000 -983,000 Extraordinary Items - - - Effect Of Accounting Changes - - - Other Items - - - Net Income 15,233,000   13,057,000   13,641,000   Preferred Stock And Other Adjustments - - - Net Income Applicable To Common Shares 15,233,000   13,057,000   ######## Period Ending 31-Dec-14 31-Dec-13 31-Dec-12 Assets Current Assets Cash And Cash Equivalents 90,208,000   88,555,000   77,268,000   Short Term Investments 47,907,000   43,981,000   48,510,000   Net Receivables 257,148,000   272,442,000   285,004,000   Inventory 17,689,000   17,325,000   15,374,000   Other Current Assets - - - Total Current Assets 412,952,000   422,303,000   426,156,000   Long Term Investments - - - Property Plant and Equipment 72,687,000   68,877,000   68,844,000   Goodwill 76,553,000   77,648,000   73,114,000   Intangible Assets 14,156,000   14,310,000   11,980,000   Accumulated Amortization - - - Other Assets 69,460,000   73,147,000   104,959,000   Deferred Long Term Asset Charges 2,541,000   275,000   -54,000 Total Assets 648,349,000   656,560,000   684,999,000   Liabilities Current Liabilities Accounts Payable 31,192,000   31,816,000   56,779,000   Short/Current Long Term Debt 101,727,000   108,014,000   131,515,000   Other Current Liabilities 75,521,000   66,742,000   61,095,000   Total Current Liabilities 208,440,000   206,572,000   249,389,000   Long Term Debt 200,414,000   221,665,000   236,084,000   Other Liabilities 102,662,000   91,540,000   71,056,000   Deferred Long Term Liability Charges - - - Minority Interest 8,674,000   6,217,000   5,444,000   Negative Goodwill - - - Total Liabilities 520,190,000   525,994,000   561,973,000   Stockholders' Equity Misc Stocks Options Warrants - - - Redeemable Preferred Stock - - - Preferred Stock - - - Common Stock 702,000   702,000   702,000   Retained Earnings 155,333,000   149,051,000   144,055,000   Treasury Stock -42,593,000 -42,561,000 -34,571,000 Capital Surplus - - - Other Stockholder Equity 14,717,000   23,374,000   12,840,000   Total Stockholder Equity 128,159,000   130,566,000   123,026,000   Net Tangible Assets 37,450,000   38,608,000   37,932,000 Cash Flow View: Annual Data | Quarterly Data Period Ending 31-Dec-14 31-Dec-13 31-Dec-12 Net Income 15,233,000   13,057,000   13,641,000   Operating Activities, Cash Flows Provided By or Used In Depreciation 9,283,000   9,762,000   9,192,000   Adjustments To Net Income -1,186,000 -1,473,000 -392,000 Changes In Accounts Receivables 2,080,000   4,333,000   2,953,000   Changes In Liabilities -210,000 2,253,000   -1,357,000 Changes In Inventories -872,000 -1,368,000 -1,274,000 Changes In Other Operating Activities 3,075,000   2,175,000   8,029,000   Total Cash Flow From Operating Activities 27,710,000   28,579,000   31,331,000   Investing Activities, Cash Flows Provided By or Used In Capital Expenditures -13,727,000 -13,458,000 -15,119,000 Investments -4,267,000 19,414,000   6,979,000   Other Cash flows from Investing Activities 12,964,000   23,161,000   19,442,000   Total Cash Flows From Investing Activities -5,030,000 29,117,000   11,302,000   Financing Activities, Cash Flows Provided By or Used In Dividends Paid -8,851,000 -7,821,000 -7,189,000 Sale Purchase of Stock 1,624,000   -8,288,000 -204,000 Net Borrowings -8,658,000 -28,102,000 -40,704,000 Other Cash Flows from Financing Activities -1,073,000 -1,362,000 -2,977,000 Total Cash Flows From Financing Activities -16,958,000 -45,573,000 -51,074,000 Effect Of Exchange Rate Changes -3,492,000 -795,000 1,278,000   Change In Cash and Cash Equivalents 2,230,000   11,328,000   -7,163,000

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