The Case of Duke Realty Corporation Analysis

To calculate the cost of capital of Duke Realty Corporation, Capital Market Pricing Model is used (CAPM). It is calculated as below

E (Ri) = rf + bi E (Rm rf)

3 months valuation

E (Ri) = 4.5%+1.3(10.2% - 4.5%)

E (Ri) = 4.5% +1.3 * 5.7%

E (Ri) = 4.5 +7.41%

E (Ri) = 11.91%

6 months

E (Ri) = 4.9% +1.3(10.2% - 4.7%)

E (Ri) = 4.9% +6.89%

E (Ri) = 11.79%

Long term

E (Ri) = 6 %+1.3(10.2% - 6%)

E (Ri) = 6% + 5.46%

E (Ri) = 11.46%

Gordon model

Value of Stock = DPS1/ (ke g)

Where,

DPS1 = Expected dividends a year to come

ke= Required rate of return for equity investors

g = Growth rate in dividends forever

Scenario 1

High growth Low growth

1.92(1+0.031) / (0.1191- 0.031) = $ 22.47 1.92(1+0.01) / (0.1191 0.01) = $ 11.18

Using Gordon model, assuming the company will experience high growth rate and the treasury bills for three months have a rate of 4.5 % (Viebig, Varmaz and Poddig, 2008). The value of share will be $ 22.47; this shows that the shares of the firm are overpriced since the current price now is $ 22.48 slightly above the value of the share. In the low growth scenario, the share is also undervalue and way below the market value. In short period, the shares are under-valued and it is advisable for the holder of the shares to sell. If the firm operates in the low growth level, one should not buy the shares since they are overvalued.

Scenario 2

High growth Low growth

1.92(1+0.031) / (0.1176- 0.031) = $ 22.85 1.92(1+0.031) / (0.1176 0.01) = $ 11.31

For six months period, when the risk-free rate is 4.9 %, and the firm experiences high growth rate, the shares are overpriced. The price is above the market price by a margin of $ 0.37. Investors should buy the shares since the price is below value meaning investing in the stock would be beneficial in the three months if the organization operates in the high growth level. If it operates in the low growth level it is advisable for investors to sell the shares they are holding since they are overvalued.

Scenario 3

High growth Low growth

1.92(1+0.031) / (0.1146- 0.031) = $ 23.68 1.92(1+0.031) / (0.1146 0.01) = $ 11.58

In the long run, when the risk free rate is 6 %, and the firm operates in the high growth scenario, the shares of the firm are overvalued. The price id the share is below the value and hence advisable for one to purchase shares. If the firm in the long run operates in the low growth scenario, the shares are undervalued and one should sell the one they have. Investors should not purchase the shares at this point since they will not maximize the value of their money.

Two-stage dividend-discount model

P0 = DPSt/ (1+kehg) t + Pn/ (1+ kehg) n

Where,

Pn = DPSn+t / (ke,st gn)

DPSt = Expected dividends per share in n years

ke = Cost of equity

Pn = Terminal value at the end of year n

g = Growth in the n years

gn = Stable state growth rate infinity

Terminal value = expected dividends per share n+1/ ke,st - g

1.56*(1+-0.01212)5* 1.031 = 1.5132

Expected dividends = 1.5132 * 0.4884 from (100% - 51.16%)

= 0.5632

Terminal price = 0.5632 / (0.1191 - 0.031) = $ 6.39

Pv of terminal value = 6.39/ 1.0315= $5.49

In case no extra ordinary growth rate and no change in payout ratio

P0 = DPS0 * (1+g)* [1-(1+g)n/(1+ ke,st)n] + DPSn+1

ke,hg - g (ke,st - g)(1+ ke,hg )n

Stable ratio in stable growth = Stable growth rate/ Stable period Return on equity

0.031/6.06 = 0.511551= 51.16 %

Expected growth rate = retention ratio * return on equity

= (1- 1.23) * 0.0606 = -0.01212 = -1.212 %

Therefore, when cost of capital is 11.91 %

1.92(1+-0.01212)[1-(0.987885/1.0315)] + 6.39/ 1.0315 = 8.460581 + 5.487739 = $ 13.95

0.031- -0.01212

Scenario 2

High growth

5.582 +8.461 = $ 14.04

Scenario 3

High growth

5.681 +8.460 = $ 14.14

Using two-stage dividend-discount model, it is advisable to sell the shares one is holding since the shares are overvalued. The prices of the share are very high as compared to the value of the shares. The value to price margin of the highest value is $ 8.34 meaning according to the model if an investor purchases the shares they will incur a lot of losses.

P/E valuation approach

P/E valuation approach = Stock Price per share / Earnings per Share (EPS)

22.48 / 1.56 = 14.41

The firm has positive earnings per share; it is advisable for the investors to purchase the shares using the model. They will get the value of their investment since they the company is getting positive earnings. The earnings per share indicate there is an assurance of dividends to the investors if they continue to be positive.

The models indicate that the company is operating in a very competitive environment, since is highly sensitive to changes (Koller, Goedhart and Wessels, 2010). The share prices are slightly overvalued in some good scenarios but widely undervalued in the worst scenarios. The degree of rivalry seems to be very high and therefore, for new firms to enter the market it would not be easy. The firms in the industry operate in almost the same profit margins except one that is way above the others. The trends indicate the competition is stiff.

References

Koller, T., Goedhart, M. and Wessels, D. (2010). Valuation. Hoboken, N.J.: Wiley.

Viebig, J., Varmaz, A. and Poddig, T. (2008). Equity valuation. Chichester, England: John Wiley & Sons.