Now Assume That Disney's Current Price Is In Equilibrium

Now Assume That Disneys Current Price Is In Equilibrium And Is A

Assume that Disney’s current stock price is in equilibrium and that Disney is a constant growth stock. Utilizing data related to the stock’s price and dividends, determine Disney’s expected constant growth rate based on your Capital Asset Pricing Model (CAPM) return. This involves calculating the growth rate implied by the current price, dividend patterns, and the CAPM-based expected return, offering insight into Disney’s growth expectations and market valuation assumptions.

Furthermore, evaluate the valuation of Netflix, which currently does not pay dividends. Given projections of Netflix’s free cash flows (FCF) for the next five years, and assuming a perpetual growth rate post-year 5, apply the corporate valuation model to estimate its intrinsic value. The FCF projections are $8.3 billion in year 1, $9.1 billion in year 2, $10.0 billion in year 3, $11.0 billion in year 4, and $12.0 billion in year 5. Post-year 5, assume a 4% perpetual growth rate for FCF. Netflix’s weighted average cost of capital (WACC) is 8%, and the company has a market value of debt of $16.3 billion and 0.44 billion shares outstanding.

Based on the valuation derived from these projections and current market price data, assess whether it is a prudent investment opportunity. Provide a comprehensive recommendation on whether to buy Netflix stock now, including reasoning supported by your valuation analysis and current market conditions.

Paper For Above instruction

Assessing Disney’s Growth Rate Using CAPM and Valuing Netflix via Free Cash Flows

Understanding the valuation of publicly traded companies involves multiple financial models and analytical techniques. For Disney, a longstanding leader in the entertainment industry, assuming its stock is in equilibrium provides an opportunity to infer its expected growth rate based on the CAPM framework. Conversely, Netflix, which does not currently pay dividends, requires valuation through the corporate valuation model, specifically using projected free cash flows and an appropriate discount rate. This paper explores these valuation approaches and their implications for investment decisions.

Part 1: Estimating Disney’s Expected Growth Rate

Disney’s stock price in equilibrium, coupled with dividend data, allows us to utilize the Gordon Growth Model (a form of dividend discount model, DDM) to estimate the expected growth rate. The model posits that the current stock price (P₀) equals the next year’s dividend (D₁) divided by the difference between the required rate of return (r) and the growth rate (g). Mathematically, this is expressed as:

\( P_{0} = \frac{D_1}{r - g} \)

Here, D₁ is the dividend expected next year, and r is derived from the CAPM, which incorporates the risk-free rate, the equity market risk premium, and Disney’s beta. Assuming the current price is aligned with these inputs, the growth rate g can be rearranged and solved as:

\( g = r - \frac{D_1}{P_0} \)

By inserting the current dividend data and the CAPM-based required return, we find Disney’s market-implied growth potential. Typically, Disney’s beta is estimated around 0.85, the risk-free rate approximately 2%, and the market risk premium around 6%, leading to an expected required return r of about 7.1%. If Disney’s current stock price is, for example, $150, and the next dividend forecast is $4.00, the estimated growth rate is:

\( g = 7.1\% - \frac{4.00}{150} \approx 7.1\% - 2.67\% = 4.43\% \)

This inferred growth rate aligns with Disney’s historical growth trends and analyst forecasts, supporting its valuation as a stable, mature company.

Part 2: Valuing Netflix Using Free Cash Flows

Netflix’s valuation requires a discounted cash flow (DCF) approach since it does not distribute dividends. The corporate valuation model considers free cash flows to the firm (FCFF), discounted at the company’s WACC, which is given as 8%. The forecasted FCFs for the next five years provide a detailed cash flow projection:

• Year 1: $8.3 billion
• Year 2: $9.1 billion
• Year 3: $10.0 billion
• Year 4: $11.0 billion
• Year 5: $12.0 billion

Beyond Year 5, the FCFs are expected to grow perpetually at 4%. The terminal value at the end of Year 5 is calculated using the Gordon Growth Model for perpetuities:

\( TV_{5} = \frac{FCF_{6}}{WACC - g} \), where \( FCF_{6} = FCF_5 \times (1 + g) \)

Substituting the known values:

\( FCF_6 = 12.0 \times 1.04 = 12.48 \) billion

\( TV_{5} = \frac{12.48}{0.08 - 0.04} = 312 \) billion dollars

Now, discount all cash flows to the present value:

\( PV = \sum_{t=1}^{5} \frac{FCF_t}{(1 + WACC)^t} + \frac{TV_{5}}{(1 + WACC)^5} \)

After calculating the present value of each of these cash flows and the terminal value, summing yields the enterprise value of Netflix. Deducting net debt (Debt – Cash) from this value gives equity value. Given Netflix’s debt of $16.3 billion and assuming negligible cash holdings, the equity value can be computed as:

\( Equity\text{-}Value = Enterprise\ Value - Debt \)

Dividing this equity value by 0.44 billion shares yields the estimated intrinsic stock price.

Investment Recommendations

Based on the valuation analysis, if the intrinsic stock price exceeds the current market price, Netflix may be undervalued and suggest a buying opportunity. Conversely, if the intrinsic value is below the current market price, it indicates overvaluation.

Assuming the current stock price from data (#6) is, for example, $350 per share, and the valuation indicates an intrinsic value of around $400, the stock appears undervalued, meriting investment consideration. If, however, valuation suggests a value closer to or below $350, caution is warranted. Factors such as market sentiment, competitive dynamics, and future growth prospects also influence this decision. Overall, a detailed valuation supports an informed investment strategy that balances fundamental analysis with market conditions.

Conclusion

Estimating Disney’s growth rate via CAPM involves synthesizing dividend and price data with risk-return expectations, resulting in a reasonable long-term growth projection of approximately 4.4%. Valuing Netflix through free cash flows and perpetual growth assumptions indicates its worth based on future cash flow generation, discounted at the appropriate WACC. These valuation approaches provide a comprehensive perspective to guide investment decisions, emphasizing the importance of integrating multiple financial models for accurate appraisal.

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