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Investment Analysis and Recommendation Paper

Investment Analysis and Recommendation Paper

Hear below is the continuation of the Investment paper, the writer will have to build on the
previouse revise paper and will add the respond to this week 5 following the template as the template
clearly stipulates what is suppose to be done and how the headings are suppose to be aligned base on
APA. All calculations doen must be reference in the paper and place in the appendix sections following

the template

� Investment Analysis and Recommendation Paper � continued

For this week’s section of your Investment Analysis and Recommendation Paper, find an estimate of beta
for your company. You might consider examining/using an industry average beta, especially if the
reported beta you find seems unrealistic or inappropriate. Note: You should probably check your beta
across a few different sources, because sometimes they vary. Find the current interest rate (yield) for 3-
month Treasury bills. Determine an appropriate market risk premium. Be sure to consider the size of your

firm when estimating an appropriate premium.

After making your calculations:

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 2
� Using all this information, what is the expected return for your company using CAPM?
� In Week 3, you estimated a required rate of return using the dividend discount model. How does your

CAPM number compare?

Write up a 1-page summary of your findings, including any calculations you might have made.

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 3

SECTION 5

Understanding company fundamentals and nature of the business is imperative for
investors before investing in any company. This can be achieved through valuation in that; the
company performance should be forecasted using an appropriate valuation model. Such
voluminous data from the research is converted so as to forecast to a valuation and make a
recommendation whether to invest or not (Lovelady, 2012).
However, this section is to analyze Chesapeake Energy Corporation Beta, the company’s
Expected Return using CAPM. Finally, the paper compares the company’s Dividend Growth
Model versus CAPM.

Debt and Equity

The cost of equity is the return a company theoretically pays out to the company equity
investors. For instance, Shareholders, to compensate them for the risk they undertake by
investing in the company.
Beta is a measure of a company’s systematic risk or volatility of its security with the
market as a whole. Chesapeake Energy Corporation is listed on New York Stock Exchange with
a market capitalization of 9.2 Billion shares. Currently, the company’s beta is 1.30 (NYSE:CHK
quotes & news – Google Finance, n.d) and fluctuates between 1.29 (Chesapeake Energy Corp,
CHK:NYQ summary – FT.com, n.d.) and 1.32 (Stock Quote CHK Chesapeake Energy
Corporation, n.d.)

Expected Return- CAPM

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 4
Capital Asset Pricing Model (CAPM) is a business model that is used to describe the
relationship between risk and the expected return. CAPM is used when pricing risky securities.
The paradigm behind CAPM is that investors need to get remunerated in two ways, that is, in
terms of risk and time value of money. The time value of money is represented by RF (Risk-
Free rate) in the equation below. The other half of the formula quantifies the risk taken by the
investor.

Where:
R F = Risk-Free Rate
Β= Beta of the Security
(R M -R F )= Expected market return
The CAPM for Chesapeake is arrived by as shown below ( See table 1):
Therefore,
CAPM= 2.33+1.30 (7-1.70)
=2.33+1.30 *5.30
=9.22%
From the calculation above, it indicates that the shareholders need 9.22% average per year over a long
period of their invested equity to make it worthwhile to invest in Chesapeake.
Debt

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 5
Cost of debt is an effective rate that a corporation reimburses on its total liability. The cost of debt is
important as it gives the overall rate the company pays to employ debt financing in business activities.
To the investor, cost of debt is imperative to give the investor an idea regarding the riskiness of investing
in the company. AS the cost of debt rises so as the risk of investing in the company.
Cost of debt( Before Tax) = Corporate Bond rate of a compnany’s bond rating. The current 20-year
corporate bond rate (BBB) is 6.69% and therefore the cost of debt is 6.69%
Current tax rate
Five year average tax rate (See table 2)= 38.01+39.04+37.50+38.49.-+38.99

= 38.41%

Cost of debt (After Tax) = ( Cost of debt before tax) (1-Tax rate)
= 0.0669* (1-0.3841) = 4.12
Therefore, the cost of debt after tax for Chesapeake =4.12%
Weighted Cost of Capital

(1 – .3841) x .0669 x ($25.211/$38.106) + .0828 ($12.895/$38.106)
.6159 x .0669 x .6616 + .0828 x .3384
.0272 + .0280
= 5.52%
Competitive review
Weighted Cost of Capital for Anadarko Petroleum Corp

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 6

WACC (See Table 3) = 6.21%* (1-631)= 7.60%

Dividend Growth Model versus CAPM

Dividend Growth model is a valuation technique that takes into account dividend per share and
the company’s expected growth (Brigham & Ehrhardt, 2013). The assumption in this model is that
dividends grow at a constant rate annually. Thus, Dividend Growth Model can be used to evaluate
companies in the stable, mature industries. For Chesapeake the dividend growth rate is 2.68% with an
EPS of $0.30. This indicates that the dividend yield is below average. However, the dividend payout is in
an uptrend and increases slowly. Compared to the CAPM, which is 9.22% is used to calculate whether
investing in Chesapeake will increase investor’s equity. CAPM is to evaluate the risk of the marketplace
compared with the risk of investing in Chesapeake. On the other hand, dividend growth model is used to
find out the consistent growth of Chesapeake dividends. The model assesses five years history of
Chesapeake stock to ascertain if the organization has consistently raised dividends.

Conclusion

From the above discussion, it is evident that Chesapeake has moderate amount of debt as well as
liabilities. This indicates that Chesapeake has the ability to pay its debts. CAPM shows that the
shareholders need an average of 9.22 per year on their equity to make a significant investment in the
company (Analyzing Chesapeake Energy’s Debt And Risk, 2015). The WACC indicates that the
company reimburses 5.52% on every dollar it uses to finance its activity. The company’s beta which is at
1.30 indicates that the company needs a minimum of 5.3 on investment and the company’s stock will
have an upward trend.

Appendix

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 7

  1. Table 1
    Risk-Free Rate 2.33%(United States Government Bonds –

Bloomberg, 2015)

Chesapeake’s Beta 1.30
Expected Market Return 7-1.70

  1. Table 2

Year Income tax/Income Tax before tax

(In billions USD)

Tax rate

2007 890/2.341 38.01%
2008 463/1.186 39-04%
2009 3.483/9.2888 37.50%
2010 1.110/2.884 38.49
2011 1.123/2.880 38.99

  1. Table 3

Value weight Required rate of

return

calculation

Equity (Fair
value)

42,626 0.71 24.16

17,400 0.29 -32.98 6.21 * (1-631%)

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 8

References

Lovelady, M. L. (2012). Profiting with synthetic annuities: Option strategies to increase yield

INVESTEMENT ANALYSIS AND RECOMMENDATION PAPER 9
and control portfolio risk. Upper Saddle River, N.J: FT Press.
United States Government Bonds – Bloomberg. (2015).

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