Finance and Accounting: Gross Domestic Product and Inflation and Interest Rate - Term Paper Example

Finance and Accounting Part It is expected that the economy of the United s shall expand steadily. The recovery of the US economy has continued to accelerate. This is anchored on strong growth in productivity and strained inflation. According to the Economic Report of the President (2015), in the past two years, it has grown at a rate of 2.8% which is 0.7% higher than the first three years of economic recovery. The growth in labor market is a major indicator of economic recovery and growth. The private sector has played a major role in both job growth and increase in economic productivity. Consequently, there has been a rise in domestic consumption which is a major driver of the economy (Economic Report of the President, 2015). The current economic growth is more sustainable due to improved structural imbalances that previously jeopardized stability. Increase in domestic energy production has minimized the sensitivity of the economy to fluctuation of foreign oil prices. This has narrowed the deficit in current account while at the same timing lessening the foreign borrowing burden. There has been an increase in domestic saving. The monetary policy has tightened while the fiscal policy has been relatively less restrictive. The US financial market is a reflection of the global outlook whereby long term interest rates have declined due to shifting monetary expectations (Economic Report of the President, 2015). Gross Domestic Product The US real GDP grew at 3.9% during the second quarter. This is attributable to growth in consumption and fixed investment. Furthermore the spending by both local and state government has made significant contribution to growth in real GDP. However, increases in import have restrained the rate of real GDP growth. Overall, the growth in real GDP implies that exports earnings have increased, personal consumption expenditure accelerated, and reduction in federal expenditure (Economic Report of the President, 2015). According to Bureau of Economic Analysis (2015) the real domestic income has increased by 0.7% during the same period. It implies that there has been a growth in corporate profits. Although the economy has been able to overcome some of the constrains of growth, the slowing down of the global markets coupled with strengthened dollar, and in adequate growth in wages poses a challenge to sustained growth. Consequently, the US economic growth remains the main anchor of the global economic recovery (Bureau of Economic Analysis, 2015). Inflation and Interest Rate The federal government has the mandate of managing the monitory policy in a manner that offers maximum employment while at the same time stabilizing prices. This is done directing monetary policy to meet a specific rate of interest rate. According to the Economist (2015), the Federal Reserve targets an inflation of 2% to achieve both maximum employment as well stabilize prices. The inflation rate is regulated by rising or reducing the interest rate to curb spending and promote spending respectively. The current inflation pressure is as result of reduction on interest rate which is aimed at promoting spending and investment (The Economist, 2015). Consumer spending A gain in job market is one of the factors that are supporting economic growth. Gains in wages increase the income, thus promoting consumption. The consumer spending was growing at a rate 2.7 % in July. However, limitations in wage gains as a result of increased employment have constrained domestic spending. In addition, business spending has reduced except in the housing sector. But increased spending by the local and state governments coupled with reduced federal spending has positively contributed to growth in GDP (The Economist, 2015). Part B Explanation: Solving Beta Before calculating the monthly return of Walmart’s stock for the period between June 2008 and June 2014, the average adjusted closing prices for each month for the period were first obtained from the Yahoo Finance website and entered into an excel spreadsheet. Similarly, the market index was obtained from the Dow Jones Industrial Average and the monthly values for the same period were entered into an excel spreadsheet. The monthly percentage returns for both Walmart’s stock and the market index were calculated using an excel function. According to Easton, Taylor, Sougiannis & Shroff (2000), the easiest way of calculating the percentage return taking one day’s or month’s price minus the previous day’s or month’s price and dividing the value by the previous day’s or month’s price. For instance, if the prices have been listed in cells B5 (month’s price) and B4 (previous month’s price), the excel function appears this way: = (B5-B4)/B4. In the given, the monthly return for Walmart’s stock in the month of June is -0.026537749. According to Easton et al (2000), this function reverts the percentages into a fraction. Beta can now be calculated after getting an array of monthly percentages for both the stock price and the benchmark index. In order to calculate Beta, an Excel regression function with the following formula was applied: =COVARIANCE.P (equity price array, index price array)/VARP.P (index price array). In the given case, Walmart’s equity price arrays are represented as columns of price data (i.e. C5:C77). On the other hand, the arrays of the benchmark index ae represented as columns of price data (i.e. E5:E77). The values go into the formula as follows: =COVARIANCE.P (C5:C77, E5:E77)/VAR.P (E5:E77). Beta in the given problem is 0.262348696. According to Brigham & Houston (2015), Beta is a measure or estimation of the volatility of a particular stock with respect to the market. A stock that has a Beta of 1.0 means that the stock’s volatility is the same as the market’s volatility. Stocks with a Beta of more than 1.0 have a higher volatility than the market, while stocks that have a Beta of less than 1.0 are less volatile than the market (Brigham & Houston, 2015). CALCULATING BETA Walmarts Stcok Prices 2008-2014 Year & Month Stcok Price Monthly Return Market Index Index Price Array May-08 48.61 0 12,638.32 0 Jun-08 47.32 -0.026537749 11,350.01 -0.101936808 Jul-08 49.35 0.042899408 11,378.02 0.002467839 Aug-08 49.93 0.011752786 11,543.55 0.014548225 Sep-08 50.63 0.014019627 10,850.66 -0.060023996 Oct-08 47.18 -0.068141418 9,325.01 -0.14060435 Nov-08 47.24 0.001271725 8,829.04 -0.053187074 Dec-08 47.59 0.007408975 8,776.39 -0.005963276 Jan-09 40 -0.159487287 8,000.86 -0.08836549 Feb-09 41.8 0.045 7,062.93 -0.117228648 Mar-09 44.48 0.064114833 7,608.92 0.077303612 Apr-09 43.03 -0.032598921 8,168.12 0.07349269 May-09 42.7 -0.007669068 8,500.33 0.040671538 Jun-09 41.58 -0.026229508 8,447.00 -0.006273874 Jul-09 42.82 0.02982203 9,171.61 0.085783118 Aug-09 43.9 0.025221859 9,172.28 7.30515E-05 Sep-09 42.37 -0.034851936 9,712.28 0.058873039 Oct-09 42.88 0.012036819 7,712.73 -0.205878537 Nov-09 47.08 0.097947761 10,344.84 0.341268267 Dec-09 46.36 -0.015293118 10,428.05 0.008043624 Jan-10 46.35 -0.000215703 10,067.33 -0.034591319 Feb-10 46.9 0.011866235 10,325.26 0.025620497 Mar-10 48.5 0.034115139 10,856.63 0.051463111 Apr-10 46.79 -0.035257732 10,008.61 -0.078110795 May-10 44.36 -0.051934174 10,136.63 0.012790987 Jun-10 42.18 -0.049143372 9,774.02 -0.035772244 Jul-10 44.91 0.064722617 10,465.94 0.070791752 Aug-10 44.25 -0.014696059 10,014.72 -0.043113184 Sep-10 47.23 0.067344633 10,788.05 0.077219333 Oct-10 47.81 0.01228033 11,118.40 0.030621845 Nov-10 47.73 -0.00167329 10,006.02 -0.100048568 Dec-10 47.86 0.002723654 11,577.51 0.157054453 Jan-11 49.76 0.039699122 11,891.93 0.027157826 Feb-11 46.13 -0.072950161 12,226.34 0.028120751 Mar-11 46.51 0.008237589 12,319.73 0.007638427 Apr-11 49.13 0.056331972 12,810.54 0.039839347 May-11 49.67 0.010991248 12,569.79 -0.018793119 Jun-11 47.8 -0.03764848 12,414.34 -0.012366953 Jul-11 47.41 -0.008158996 12,143.45 -0.021820733 Aug-11 48.19 0.016452225 11, 613.53 0.020071695 Sep-11 47.02 -0.024278896 10,913.38 0.020071695 Oct-11 51.39 0.092939175 11,955.01 0.095445224 Nov-11 53.37 0.038528897 12,045.68 0.007584268 Dec-11 54.48 0.020798201 12,217.56 0.014269016 Jan-12 55.94 0.026798825 12,632.91 0.03399615 Feb-12 53.86 -0.037182696 12,952.07 0.025264171 Mar-12 56.17 0.042888971 13,212.04 0.020071695 Apr-12 54.07 -0.037386505 13,213.63 0.000120345 May-12 60.82 0.124838173 12,393.45 -0.062070756 Jun-12 64.42 0.059191056 12,880.09 0.039265903 Jul-12 68.77 0.067525613 13,008.68 0.009983626 Aug-12 67.45 -0.019194416 13,090.84 0.006315783 Sep-12 68.56 0.016456635 13,437.13 0.026452848 Oct-12 69.69 0.016481914 13,096.46 -0.025352884 Nov-12 66.91 -0.039890946 13,025.58 -0.00541215 Dec-12 63.74 -0.047377074 13,104.14 0.006031209 Jan-13 65.35 0.025258864 13,860.58 0.057725269 Feb-13 66.12 0.011782708 14,054.49 0.013990035 Mar-13 70.36 0.064125832 14,578.54 0.037287016 Apr-13 73.07 0.038516202 14,839.80 0.017920862 May-13 70.79 -0.031202956 15,115.57 0.018583135 Jun-13 70.46 -0.004661675 14,909.60 -0.013626347 Jul-13 73.72 0.046267386 15,499.54 0.039567795 Aug-13 69.45 -0.057921867 14,810.31 -0.044467771 Sep-13 70.38 0.013390929 15,129.67 0.021563357 Oct-13 73.03 0.037652742 15,545.75 0.02750093 Nov-13 77.09 0.055593592 16,086.41 0.034778637 Dec-13 75.32 -0.022960176 16,576.66 0.030476035 Jan-14 71.48 -0.050982475 15,698.85 -0.052954576 Feb-14 71.5 0.000279799 16,321.71 0.039675518 Mar-14 73.62 0.02965035 16,457.66 0.008329397 Apr-14 76.78 0.042923119 16,580.84 0.007484661 May-14 74.41 -0.030867413 16,717.17 0.008222141 Jun-14 72.76 -0.022174439 16,826.60 0.006545964 Part 3: Estimating the Intrinsic Value of a Stock The dividend per share that was paid by Walmart in June 2014 is 0.48. According to Brigham & Houston (2015), the required rate of return (RRR) can be defined as the minimum yearly percentage that is earned by an investment that will encourage companies or individuals to invest their money in a certain security. The required rate of return is used in equity valuation as well as in corporate finance. Investors often use the RRR to make a decision on where to invest their money. Investors compare the return on a particular investment to all the available options by considering the risk-free rate of return, liquidity and inflation in their calculations. In the case of investors who use the dividend discount model to choose stocks, the required rate of return will affect the maximum price that the investors will be willing to pay for a particular stock (Brigham & Houston, 2015). One way of calculating the RRR is through the Capital Asset Pricing Model (CAPM). The model calculates the expected rate of return on the basis of the expected rate of return on the market, the beta coefficient of the stock, and the risk-free rate. The formula for the CAPM is as follows: E (R) = R f + β (R market – R f). In this formula, E (R) denotes the required rate of return, R f is the risk-free rate of return, β is the beta coefficient of the stock, and R market is the expected rate of return on the market (Brigham & Houston, 2015). Therefore, in the given scenario, the RRR on Walmart’s stock would be as follows: E (R) = 9% + 0.262348696 (15% - 9%) = 0.02114092176 or 2.11%. The RRR on Walmart’s stock is equivalent to 2.11% when calculated using the Capital Asset Pricing Model. According to Brigham & Houston (2015), the intrinsic value of a stock can be defined as the underlying “fair” value of the company. This value is always independent of other extraneous factors. One method of calculating the intrinsic value of a stock is the constant growth dividend valuation model. This model assumes that the company’s growth rate is constant. Brigham & Houston (2015) further notes that the model is best suited for big, stable companies that have consistent dividends and earnings. The formula for the model is as follows: Sock Price = D1/ (k-g). Where D1 is equal to the dividend for the coming year, K is equal to the required rate of return (RRR), and g = growth rate of dividends. Brigham & Houston (2015) also point out that k must be greater than g, and decimals rather than percentages must be used in order for the model to work. In the given scenario, the intrinsic value of Walmart’s stock would be calculated as follows: (assuming that g is 0.015 or 15%) Stock Price = 0.48/ (0.02114092176 – 0.015) = $78.1641. This valuation for Walmart’s stock is slightly higher that the company’s stock price of $73.26 as at 30, June 2014, which leads to the assumption that Walmart’s shares may be slightly undervalues. List of References Brigham, E. & Houston, J. (2015) Fundamentals of Financial Management. 14 ed. Connecticut, Cengage Learning. Bureau of Economic Analysis (2015). Gross Domestic Product. Retrieved from https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm Easton, P. D., Taylor, G. K., Sougiannis, T., & Shroff, P. K. (2000). Empirical estimation of the expected rate of return on a portfolio of stocks. Available at SSRN 242822. The Economic Report of the President (2015). Retrieved from https://www.whitehouse.gov/sites/default/files/docs/cea_2015_erp.pdf The Economist (2015). The Feds Plan to hike Interest Rates. Retrieved from http://www.economist.com/blogs/economist-explains/2015/08/economist-explains-21 Read More