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Valuation Conclusion

Part 1

            An investor may experience, and must have different risk types. These risks, including the beta risk, comprise the industry-specific-risk, market risk, and indiosyncratic risk. According to Hickman et al. (2013), indiosyncratic risk implies to the inherent factors, which can contrarily affect the individuals’ securities, or a specific asset groups in a negative manner. It is considered a diversified risk

 On the other hand, a systematic risk is perceived to be the opposite of the idiosyncratic risk. It is viewed as a risk to the market or market segments. It not only affect a specific industry or stock, but it affect the market in general. The type of risk is considered as unpredictable, and cannot be avoided completely (Böni & Zimmermann, 2021). Additionally, industry-specific risk to the investor is viewed as hazardous, and applies only to the specific company (John Deere) or the manufacturing industry. It is also determined as diversifiable risk or unsystematic risk, and is the opposite of both the systematic and market risk.

            The require rate of return is determined as the minimum return expected from an investor. Here, beta is important in the evaluation on investment in a project. The ability to estimate the required rate of return, as well as determine the beta asset (Reis & Augusto, 2019). The focus and concern of the investors is if the risk can or cannot be diversified. In this case, individual risks (industry-specific, idiosyncratic, and unsystematic risk) are viewed as diversifiable. Hickman et al. (2013) considers non-diversifiable risk comprise economic risk, market risk, and systematic risk.

Part 2

            Yahoo! Finance (2021) indicated that John Deere’s beta was 1.07. Beta, in finance, is a measure of how an individual asset moves, on average, during a decrease or an increase in the stock market. The market is viewed as a benchmark – an asset that has a beta of above 1.0 like John Deere is more erratic than the less erratic stock with a better of 1.0 or less (Yahoo! Finance, 2021). Simply put, beta is a determiner of the volatility of a stock in relation to the overall market. As is the case of John Deere, high-beta stocks of over 1.0 are expected to be riskier, but provide higher return potential.

            John Deere’s required rate of return is calculated using the CAPM (capital asset pricing model). The equation is as follows:

The required rate of return = risk free rate of return.

(R_t plus stock’s beta (β) (market risk premium).

In this case, to determine John Deere’s required rate of return, a 2% risk free rate of return, a 5% market risk premium, and a 1.07 beta was used.

Required Rate of Return (r)

Assumptions:

Rate of return – 2.14%

Expected rate of return on market portfolio – 11.72%

Systematic common stock risk – 0.87

John Deere’s common stock’s required rate of return – 14.40%

= 2.14% + 0.87 (11.72% – 2.12%)

= 12.61%

Deere & Co. require rate of return is 12.61%. It is above the 10% rate of capitalization discount used in the constant rate of growth. The 12.61% required rate of return is the minimum return, which investors are likely to accept to invest in Deere & Co.

To calculate the RRR using the CAPM formula, the risk-free rate of return is subtracted from the market rate of return (Yahoo! Finance, 2021). The figure is then multiplied using the security beta. The finding is added to the result using the risk-free rate to determine the RRR.

Market risk premium = 6%

Risk-free rate of return = 2%

6% – 2% = 4%

Beta = 1.07

4% x 1.07 = 4.28

4.28 + 4%

RRR = 8.28%

In comparison to the required return based on the size used in the finding from the previous evaluation for the constant growth formula (10.15%), the company-specific required rate of return calculated above (8.23%) is lower. The differences in the RRR from the two evaluation represents the investment riskiness being made. The difference is a reflection of the compensation the investor is willing to handle for the risk born. This means that the difference by 1.92 means the investor is more willing to risk given the difference in the rate of return is minimal (Reis & Augusto, 2019). The differences in RRR means the investment is worth it the cost, while giving ideas as to the amount the investor expect to make after making an investment.

Part 3

Low-end dividend growth rate

            Rate of Return = (Dividend Payment / Stock Price) + Dividend Growth Rate.

            10% / 363.07 + 0.99%

            0.0275 + 0.99

            1.02%

High-end dividend growth rate:

             Rate of Return = (Dividend Payment / Stock Price) + Dividend Growth Rate.

            10% / 399 + 0.99%

            0.0250 + 0.99

            1.015 x 10

            10.15%

            One of the growth rate is lower than the new CAPM discount rate (8.23%). Another one is above (10.15%) the new discount rate. The recalculated stock price is as follows:

Constant growth formula:

            P = D/(r-g)

            P – Current price

            D – Next dividend the company will pay

            g – Expected growth rate

            r – Required rate of return

$3.6 / (10% – 0.48)

            $3.6 / 9.52 x 100

            3.78 x 100

            $378

            In this case, the reason for the revised growth rates is the changes in the rate of return attribute to different formulas. The revised high-end and low-end stock price calculations are as follows:

            High-end stock price:

            P = D/(r-g)

            P – Current price

            D – Next dividend the company will pay

            g – Expected growth rate

            r – Required rate of return

$3.6 / (10.15% – 0.48)

            $3.6 / 9.67 x 100

            3.48 x 100

            $348

Low-end stock price:

$3.6 / (8.23% – 0.48)

            $3.6 / 7.75 x 100

            2.697 x 100

            $270

            The recalculated high-end stock price is below ($348) is below the current stock price per share of Deere& Co. ($363.07). Again, the recalculated low-end stock price ($270) is also below the current stock price ($363.07). Additionally, the recalculated stock price (both high-end and low-end) indicates that the current stock price of Deere & Co. is currently overvalued in the market.

            According to Böni & Zimmermann (2021), analysts and investors consider stocks that have a P/E ratio of 50 or above to be an overvalued, more so in comparison to stocks with ratios at par or below 10. In this case, the high-end and low-stock prices for Deere & Co. indicate that they are overvalued, thus the investors should pay attention to the share prices, and the growth rare as they relate to dividends. At the same time, using the required rate of return, a shorting strategy should be adopted to assist in reaping gains from the portfolio, but are often without risks (Reis & Augusto, 2019). Thus, the option for investors should involve borrowing and selling stocks at their current price, and repurchasing them at when they are lower.