HandsOn Empirical Research Assignments

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Hands-On Empirical Research Assignments

• Stock price reaction to accounting announcements
• Valuation of firm

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1. Stock Price Reaction

• Find a recent announcements of earnings, stock
  split, law suit, etc.
• E.g., something that could be considered to have
  information content whether GN or BN
• Best to find company that doesnt have multiple
  announcements within same month
• Get stock prices for month before and after the
  date of the announcement
• Graph stock price surrounding announcement date
• Better compute cumulative return as
  demonstrated in the Xerox example file the
  graph will present impact much more clearly!

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1. Stock Price Reaction (cont)

• Find an appropriate market indicator (might be
  industry-related index, SP 500, etc.
• On same graph, plot price movement of the market
  surrounding the date of the announcement better
  yet, do the cumulative return for the market
• Write short essay (one or two paragraphs)
  explaining whether the announcement seemed to
  have information content

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2. Use Ohlson Theory To Estimate Firm Value

• Follow Example 6.2 Process (Bombardier Inc)
• Pick a company youre interested in and apply the
  methodology
• Compare the projected stock price to current
  stock price

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2. Use Ohlson Theory To Estimate Firm Value -
hints

• You will need beginning and ending book value,
  current year earnings, dividends, and common
  shares outstanding
• You will need your companys BETA
• At Yahoo, my companys beta was listed as N/A
• Found it at MSN Money Central (see links next
  slide)
• You will need a risk free interest rate
• I used 10-year US Treasury Notes found at
  http//wwws.publicdebt.treas.gov/AI/OFAuctions
• Would it be better to use a long-run average???

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2. Use Ohlson Theory To Estimate Firm Value -
hints

• You also need a market return rate
• I did a bit of googling but mostly hit
  roadblocks because sites wanted for data!
• Found article in Sun-Times (6/17/04) by Terry
  Savage, Expect more modest gains in stocks over
  next decade which said long-run return has
  averaged 10.4
• Could download a stock index data (as you did for
  the event study) and compute your own market
  return estimate

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You will need to estimate your companys cost of
capital

• Plug in your risk free rate, market rate of
  return and BETA into the CAPM formula
• E(Rjt) Rf(1 - ßj) ßjE(RMt)
• For ßj finance.yahoo.com
• Call up company in question, click on Profile
• You can also try http//moneycentral.msn.com/inves
  tor/home.asp

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Other hints

• Being an excel-person I wanted to analyze my
  company that way rather than by hand
• To de-bug my formulas, I entered the text example
  data (and yes, I found I had at least one
  mistake!)
• You need to pick a time-horizon
• Text used 7 years
• I decided 10 years was reasonable for my company
  (WFMI)

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Other hints

• You could also factor in persistence in the
  abnormal earnings and maybe analysts projections
  of earnings, particularly if your answer, like
  mine, was a whole lot lower than actual market
  value!

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Estimating Abnormal Earnings

• Choose a time horizon (e.g., 7 years) over which
  abnormal earnings will persist
• Calculate ROE
• Calculate dividend payout ratio (k)
• Year-by-Year Over Time Horizon
• Project book value
• End-of-year BV Opening BV (1-k)NI

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Estimating Abnormal Earnings, Contd

• Estimate actual earnings
• Estimated Actual Earnings ROE x Opening BV
• Calculate expected (i.e., normal) earnings
• Cost of Capital x Opening BV
• Abnormal earnings actual earnings - expected
  earnings

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Estimating Firm Value, Concl.

• Calculate PV of Abnormal Earnings at Cost of
  Capital Over Time Horizon
• Estimated Firm Value Net Assets PV of
  Abnormal Earnings
• Divide by shares outstanding to get anticipated
  PRICE per share
• Compare to market
• Reasonable?