CHAPTER 9: COMMON STOCK VALUATION

1. Determine the price of a share of stock whose last annual dividend payment (D0) was $1.50,
assuming a required rate of return of 12% and considering the following:
a) The dividend payment is expected to remain constant (i.e., g = 0) indefinitely.
b) The dividend payment is expected to grow at a constant rate of 3% per year indefinitely.
c) The dividend payment is expected to grow at a rate of 8% for four years and then immediately decline
to 3% indefinitely. Calculate your solution twice, the first time using formula 9-5 on page 260, and
the second time using the FAME_TwoStageValue user-defined function.
d) The dividend payment is expected to grow at a rate of 8% for four years and then gradually decline
over a three year transition period to 3% indefinitely. Calculate your solution twice, first time using
formula 9-8 on page 264, and the second time using the FAME_HModelValue user-defined function.
e) Using the same assumptions as in part d, calculate the value of the stock using the
FAME_ThreeStageModel user-defined function.
f) How do the calculated intrinsic values compare to the current price of $16? Use an IF statement to
display whether the stock is undervalued, overvalued, or fairly valued.

2. The following table contains information about the estimated next year’s EPS, payout ratio,
shareholders’ required rate of return, and return on equity of four different companies:
Company A Company B Company C Company D
EPS $0.75 $1.00 $1.25 $1.50
Payout Ratio 30% 50% 60% 40%
Required rate of Return 13% 11% 12% 14%
ROE 16.00% 15.00% 14.00% 16.00%
a) Calculate each company’s future earnings growth rate. Using the earnings model, what is the value of
the stock?
b) Using the constant-growth dividend discount model, what is the value of the stock?
c) Assume that the companies will experience the growth rate determined in part (a) for a short period of
time, and after that the firms will grow at a lower rate. These periods of time and second growth rates
are the following:
Company A Company B Company C Company D
Growth Rate #2 5.00% 4.00% 3.00% 4.00%
Growth Rate #1 Time 2.00 years 3.00 years 4.00 years 3.00 years
Using the two-stage dividend growth model, what is the value of the stock? Calculate your solution
twice, first using equation 9-5 on page 260, and then using the FAME_TwoStageValue function.
d) Assume that the transition between growth rates 1 and 2 will be gradual rather than instantaneous.
The forecasted transition periods are the following:
Company A Company B Company C Company D
Transition Period 3.00 years 4.00 years 2.00 years 4.00 years
Using the H model, what is the value of the stock? Calculate your solution twice, first using equation
9-8 on page 264, and then using the FAME_HModelValue user-defined function.
e) Create a Scatter chart to show the relationship between the value of the stock and the dividend payout
ratio using Company D. Can you observe any price that is extremely different from the rest? Interpret
your results.