Written Assignment Assessment Answer

Part A

Step 1

In 1849, German scientist and businessman Charles Pfizer and his cousin Charles Erhart, who was a candy maker, started Charles Pfizer & Company in Brooklyn, New York. This was the start of the company Pfizer. At first, the business was a fine-chemicals business. Pfizer's father gave the business a $2,500 loan to help it get started.

AbbVie aims to discover and provide novel pharmaceuticals that address prevalent health issues of the present and anticipate potential medical challenges of the future. Allergan strives to have a significant impact on individuals across various therapeutic domains, including immunology, oncology, neuroscience, eye care, virology, women's health, and gastroenterology. Additionally, Allergan offers products and services in the field of Allergan Aesthetics.

Step 2

Answer A

The specifications of the FCFE model is as follows:-

• No dividends are paid by the company.
• The company pays dividends, but the profits paid are significantly lower than what could be paid.
• Profitability and free cash flow coincide within a reasonable timeframe that the analyst finds satisfactory.
• The investor views the situation from a "control" perspective. With authority comes the liberty to determine how to utilize free cash flow.
• If a shareholder has the ability to seize control of a company or expects another investor to do so, dividends may be drastically altered. For instance, they may be set at a level near to the company's dividend-paying capacity (Dirman, 2020).

Answer B

Table 1: Firm Valuation through free cash flow method(Source: As Created by Author)The valuation of the equity is determined through summation of all the cash flows. The FCFE model also reflects the working capital of the firm.Therefore, the valuation of the company is estimated to 1800 dollarsAnswer CThe discounted cash flow analysis is a way to estimate the value of an investment by taking into account how much cash it is likely to bring in over time. To figure out how much a business is worth, one look at dividends, earnings, working cash flow, and free cash flow to come up with a rate of return or discount rate. With this method, a business can be valued without taking into account other market factors.The Discounted Cash Flow method lets you figure out objective values that don't depend on the market. This method is seen as more objective than other ways to value something because it doesn't depend on how people feel about it on the market. Even if the market misprices a company for a short time, the discounted cash flow study is not affected.DCF takes into account the long-term value of a possible investment when figuring out its value. Using the idea of how money changes over time, the Discounted Cash Flow method estimates how much money an investment will bring in over a long period of time. With this method, investors can guess how long it will take to get a certain rate of return (Qiu et al. 2021)The Discounted Cash Flow method is a complicated and thorough way to value something. The DCF method uses cash flow forecasts and discount rates, among other assumptions about a company, to get numbers and metrics that can be measured. Assuming that these factors are true, it is possible to get a complete valuation of a company or investment.Answer DThe assumptions of discount cash flow valuation can affect the overall valuations of the organization. One generally used two-stage model assumes a constant growth rate across both stages, whereas another widely used model assumes a growth slowdown in the first stage, followed by an increase in the rate of growth that is sustainable over the long term in the second stage.To make accurate forecasts of FCFF and FCFE, analysts use a variety of models that range in complexity. The forecasting of sales numbers is a practice that sees widespread application. Profitability, investments, and financing are all made conditional on variations in sales.The utilization of three-stage models is generally considered to be an appropriate estimation for cash flow streams that display year-to-year variability in reality. This is because of the fact that three-stage models have three distinct stages. Companies typically keep their non-operating assets, such as excess cash and marketable securities, long-term investment securities, and nonperforming assets, in a distinct section of their balance sheets from their operating assets. After completing each asset's unique valuation, the results are merged with those of the company's operational assets to arrive at an estimate of the total value of the business (Agrawal & Nasser, 2019).Answer EThe discounted cash flow valuation of AbbVie is as follows:-

Earnings before interest and taxes =

15707

Expected growth for next 5 years =

20%

Expected growth after year 5 =

20%

Tax rate =

30%

Debt ratio for the firm =

374%

Cost of equity =

16%

Pre-tax cost of debt =

7%

Return on capital in high growth=

11%

Return on capital in stable growth =

10%

0

1

2

3

4

Expected Growth rate

20%

20%

20%

20%

Reinvestment rate

181.82%

181.82%

181.82%

181.82%

EBIT

 $ 15,707.00

 $ 18,848.40

 $ 22,618.08

 $ 27,141.70

 $ 32,570.04

Taxes

 $ 5,654.52

 $ 6,785.42

 $ 8,142.51

 $ 9,771.01

EBIT(1-t)

 $ 13,193.88

 $ 15,832.66

 $ 18,999.19

 $ 22,799.02

 - Reinvestment

 $ 23,988.87

 $ 28,786.65

 $ 34,543.98

 $ 41,452.77

FCFF

 $ (10,794.99)

 $ (12,953.99)

 $ (15,544.79)

 $ (18,653.75)

Terminal Value

Present Value

 $ (14,483.80)

 $ (23,319.74)

 $ (37,546.12)

 $ (60,451.41)

Value of Firm =

 $ (1,35,801.07)

 $ (90,419.59)

-54437.09783

-25028.00149

0

Value of Equity =

 $ 3,71,538.14

! Equity as % of value

Value of Debt =

 $ (5,07,339.21)

! Debt as % of value

EBIT

 $ 15,707.00

 $ 18,848.40

 $ 22,618.08

 $ 27,141.70

 $ 32,570.04

Interest Exp

 $ (35,513.74)

 $ (23,645.90)

 $ (14,236.01)

 $ (6,545.15)

EBT

 $ 54,362.14

 $ 46,263.98

 $ 41,377.70

 $ 39,115.18

Taxes

 $ 16,308.64

 $ 13,879.19

 $ 12,413.31

 $ 11,734.55

Net Income

 $ 38,053.50

 $ 32,384.79

 $ 28,964.39

 $ 27,380.63

 - Reinvestment

 $ 23,988.87

 $ 28,786.65

 $ 34,543.98

 $ 41,452.77

 + New Debt Issued

 $ 1,69,540.65

 $ 1,34,427.01

 $ 1,09,869.44

 $ 93,502.11

FCFE

 $ 1,83,605.28

 $ 1,38,025.15

 $ 1,04,289.86

 $ 79,429.97

Terminal Value of Equity

Present Value

 $ 1,58,280.41

 $ 1,02,575.17

 $ 66,814.10

 $ 43,868.46

Value of Equity =

 $ 3,71,538.14

The above table reflects that PFIZER has performed well in comparison with Briscoe Group. The cash flows of PFIZER are on the higher side and thus the valuation of the company is on the higher side. The market yield is also on the higher side, which can be considered as a positive sign for both the organizations (Dirman, 2020).

Step 3

As per the findings, the given stock should be kept as hold, as the stock price of Pfizer is expected to increase as per company valuation.

Part B

Answer

The selected company is PFIZER healthcare. The stock prices of last 5 years have been taken and compared with S&P market index.The characteristic line of the company is as follows:-

Figure 1: Security Market Line(Source: As Created by Author)

The Security Market Line or SML is a picture of how much a security is projected to earn based on how much systematic risk it takes on. The Securities Market Line (SML) is a tool that investors use to figure out if it would be a good idea to add a certain asset to their portfolio (Wihartati & Efendi, 2021).The X-axis of the graph shows the measure of systemic risk, which is called beta. This is the independent variable. On the other hand, the Y-axis is used to plot the dependent variable, which are the expected yields. The SML starts from the amount of risk-free returns on the Y-axis. The above graph reflects that the portfolio has performed well in comparison to the market expectations.

Answer B

The cost of capital for a business is the least rate of return or profit it must make to be worth something. It is used by an organization's accounting team to review possible investment returns and figure out how much financial risk there is (Fernandez, 2019).Business leaders use the cost of capital to figure out how much money a new business needs to make to break even. It is also used to figure out how dangerous business choices might be. The cost of capital is a very important measure for both investors and analysts. It is used by these companies to predict the prices of stocks and the returns on investments.

If a company's financial accounts or cost of capital are unstable, for example, the price of its shares may drop and investors may decide not to support it (Widyasti & Putri, 2021). It has been realized that the combination of capital cost and risk is a significant issue. During the course of their work, they've realized that their aims and interests are comparable to those of the financial expert and the managerial economist, who have worked with the issue for longer and more extensively. In a world with a great deal of uncertainty, there are primarily two methods in which individuals collaborate to determine the rules that make business and financial policy sensible. The lines above can be interpreted as attempts to apply the profit maximization and market value maximization criteria, which were originally believed to have the same effects in certain circumstances, to uncertain situations as well. This equality disappears once we acknowledge that we do not know everything. There is currently no adequate method to describe the metric for maximizing profits. In uncertain situations, a company's decision-making process yields a variety of methods to generate revenue, none of which are optimal. Only a subjective probability distribution can adequately characterize these potential outcomes. Profit maximization has lost its practical significance due to its transformation into a random variable.

The majority of the time, it is not possible to solve the problem we just discussed by using the mathematical expectation of profits as the variable to be optimized. It is probable that decisions that alter the expected value will alter the distribution of results, including dispersion and other related characteristics. Using debt financing instead of equity financing for a particular business venture could potentially increase the proprietors' expected returns. In exchange for this advantage, however, the effects are more apt to be distinct.

The cost of capital is as follows:-

0.0108640

Monthly Cost of Equity

0.13036851

Annually Cost of Equity

13%

Table: Cost of Equity of Pfizer

0.0131707

Montly Cost of Equity

0.158048894

Annually Cost of Equity

16%

Table: Cost of equity of AbbvieAnswer CThe Capital Asset Pricing Model is a model that illustrates the connection between the expected return and the associated risk of securities. That a security's expected return is equal to the risk-free return plus a risk premium determined by its beta is demonstrated by the statement. To examine how an organization's predicted profits relate to its investment risk, financial analysts employ CAPM (Wihartati & Efendi, 2021).The expected market return of the company is as follows:- 

Risk free rate of return =

126.12%

Beta =

1.43

Expected Market Return =

-5.10%

Required Rate of Return =

-61.128%

Table 4: CAPM Calculation(Source: As Created by Author)The above table reflects that the required rate of return will be around 13.5 percent, which can be considered as a very good sign for the firm.

References

Agrawal, A., & Nasser, T. (2019). Blockholders on boards and CEO compensation, turnover and firm valuation. Quarterly Journal of Finance, 9(03), 1950010.Dirman, A. (2020). Financial distress: the impacts of profitability, liquidity, leverage, firm size, and free cash flow. International Journal of Business, Economics and Law, 22(1), 17-25.Fernandez, P. (2019). Three residual income valuation methods and discounted cash flow valuation.Pramono, E. S., Rudianto, D., Siboro, F., Baqi, M. P. A., & Julianingsih, D. (2022). Analysis investor index Indonesia with capital asset pricing model (CAPM). Aptisi Transactions on Technopreneurship (ATT), 4(1), 35-46.Pramono, E. S., Rudianto, D., Siboro, F., Baqi, M. P. A., & Julianingsih, D. (2022). Analysis investor index Indonesia with capital asset pricing model (CAPM). Aptisi Transactions on Technopreneurship (ATT), 4(1), 35-46.Qiu, S. C., Jiang, J., Liu, X., Chen, M. H., & Yuan, X. (2021). Can corporate social responsibility protect firm value during the COVID-19 pandemic?. International Journal of Hospitality Management, 93, 102759.Wihartati, A. P., & Efendi, T. F. (2021). Decision Support System for Share Investment Using The Capital Assetpricing Method (CAPM). International Journal of Computer and Information System (IJCIS), 2(1), 19-23.Wihartati, A. P., & Efendi, T. F. (2021). Decision Support System for Share Investment Using The Capital Assetpricing Method (CAPM). International Journal of Computer and Information System (IJCIS), 2(1), 19-23.Widyasti, I. G. A. V., & Putri, I. G. A. M. A. D. (2021). The effect of profitability, liquidity, leverage, free cash flow, and good corporate governance on dividend policies (empirical study on manufacturing companies listed in indonesia stock exchange 2017-2019). American Journal of Humanities and Social Sciences Research (AJHSSR), 5(1), 269-278.Zuhroh, I. (2019). The effects of liquidity, firm size, and profitability on the firm value with mediating leverage. 

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