Question

a)Salamander Corporation has just announced a £1.50 per share dividend for the upcoming year (with the company having 2 million shares outstanding). The board has also announced that both sales and targets are looking positive and that they expect dividends to grow at a rate of 5% per year indefinitely. The stock of Salamander Corporation has a beta of 0.8 while the expected market return and risk free rates are 22% and 5% respectively.

The company's accountant also estimate that with further investment, the future cash flows of the company are to be as follows (2014 is termed year zero):

2014	2015	2016	2017	2018-2030
£6.4 mil	£7.2 mil	£7.5 mil	£8.2 mil	£8.5 mil p.a

Q: Compare and contrast the alternative approaches of fundamental analysis and technical analysis in assessing the prospects of a future investment opportunity. Your answer should include a(-) relevant example(s) of each methodology.

Answer 1

Using CAPM, Cost of equity, r = Rf + beta x (Rm - Rf) = 5% + 0.8 x (22% - 5%) = 18.6%

Share Price, P0 = D1 / (r - g) = 1.50 / (18.6% - 5%) = £11.03

Using free cash flow valuation,

Terminal Value in year 2017, TV = FCF2018 / r = 8.5 / 18.6% = 45.7 million

Equity Value today = FCF1 / (1 + r) + FCF2 / (1 + r)^2 + (FCF3 + TV) / (1 + r)^3

= 7.2/1.186 + 7.5/1.186^2 + (8.2 + 45.7)/1.186^3

= 43.71 million

Share Price today = Equity / No. of shares = 43.71 / 2 = £21.86