Lenovo Group Limited A Good Investment for the Fund Case Solution

Estimation of Beta and WACC

The First step in the process of FCF valuation comprises estimating the beta of the company. The beta is defined as the covariance of the markets and stock return divided by the variance of the market returns. Lenovo is listed on the Hong Kong Stock Exchange. It is advisable that the analysts’ estimates of beta are examined in detail. For this purpose, the estimates of renowned financial databases including Reuters, financial times, Morningstar and Google finance are taken into account. Every database takes into account the different periods for calculating beta. The betas of Morningstar and Google finance are based on a 52-week period while Reuters and financial times utilize lesser period (Reuters, 2014) & (Finacial Times, 2014)&(Morningstar, 2014) & (Google, 2014). For this purpose, it is wise to stick to a 52-week beta because it is more depictive of the stock price returns. Hence, the average of the two betas (Morningstar and Google finance) is assumed to be the projected beta for Lenovo. Its value comes out to be 0.795. In the estimation of the WACC, the following points elucidate the calculations.

• Only the after-tax rate on debt is taken.

• The risk-free rate is assumed to be equal to the yield on 30 years of government treasuries.

• Debt only comprises ‘long term debt’ figures.

• Equity value constitutes the final figure and includes the book value.

The following table depicts the calculations. The WACC stands at 6.24%.

Table 1: Beta and WACC

DCF Valuation

The key assumptions for the valuation are listed in the following table.

Table 2: Assumptions and Inputs

The tax rate is assumed to be equal to the slab which corresponds to greater then £300,000 profits (Government of UK, 2014). Long term growth rate is assumed to be equal to the long term forecasted dividend yield. Based on the above-mentioned assumptions, the formulation of DCF valuation is described in the following table: