I have used this assignment on numerous occasions. Most students seem to enjoy it. I find that application of the “recipe” to value Canadian Tire Corp. in Section 6.5.3 is usually well done, although the instructor may assist students to evaluate the expected return on the market by discussing the concept of market risk premium described in Note 39 of this chapter. Stocks’ betas are usually available on the internet—Reuters and Yahoo Finance are good sources. If not, it is relatively straightforward to estimate beta directly, based on the formula given in Section 4.5 and 25 or more days of data. A complication is that many Canadian firms have a dual common share structure—see Note 40. While rather ad hoc, I suggest simply adding the number of shares of each class.
The main problem students have with this assignment is to see beyond simply applying the procedure. Consequently, an important part of the assignment is to consider the effect of recognition lag, such as for R&D, on the calculations, to consider the pattern and length of time that abnormal earnings are expected to persist, and consider any analyst forecasts. In my opinion, the main reason that the estimated share value often differs substantially from actual market share price is that the market has greater or lesser expectations about the amounts and duration of abnormal earnings than the horizon used in the analysis (I use a 7 year constant horizon for Canadian Tire, with no abnormal earnings beyond 7 years), possibly because of analyst forecasts. I recommend discussing with the students (I do it after the graded assignment is handed back) issues surrounding the assumptions about abnormal earnings, although in an undergraduate course I do not go into the terminal value problem of estimating firm value beyond the specific earnings forecast horizon.