Your boss, Sally Maloney, treasurer of Fred Clark Enterprises (FCE), asked you t

Question

Your boss, Sally Maloney, treasurer of Fred Clark Enterprises (FCE), asked you to help her
estimate the intrinsic value of the company's stock. FCE just paid a dividend of $1.00, and the
stock now sells for $15.00 per share. Sally asked a number of security analysts what they
believe FCE's future dividends will be, based on their analysis of the company. The consensus is
that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of
5% per year in Year 4 and thereafter. Sally asked you to use that information to estimate the
required rate of return on the stock, rs, and she provided you with the following template for use in
the analysis.
Sally told you that the growth rates in the template were just put in as a trial, and that you must
replace them with the analysts' forecasted rates to get the correct forecasted dividends and then
the estimated TV. She also notes that the estimated value for rs, at the top of the template, is also
just a guess, and you must replace it with a value that will cause the Calculated Price shown at
the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct
dividends, you can manually calculate the price, using a series of guesses as to the Estimated rs.
The value of rs that causes the calculated price to equal the actual price is the correct one. She
notes, though, that this trial-and-error process would be quite tedious, and that the correct rs
could be found much faster with a simple Excel model, especially if you use Goal Seek. What is
the value of rs?
a. 11.84%
b. 12.21%
Estimated r
s
= 10.00% (must be changed to force Calculated Price to equal the Actual Market Price)
$15.00
Year 0 1 2 3 4 5
Dividend growth rate (insert correct values) 10% 10% 10% 5% 5%
Calculated dividends (D0
has been paid) $1.00 ? ? ? ? ?
TV3
= P3
= D4
/(r
s ? g4
). Find using Estimated r
s
. ?
Total CFs ? ? ?
PVs of CFs when discounted at Estimated r
s ? ? ?
Calculated Price = P0
= Sum of PVs = $0.00 A positive number will be here when dividends are estimated.
The Calculated Price will equal the Actual Market Price on

Explanation / Answer

The way to solve this in excel: find the PV of the dividend in each year. Year 1 Year 2 Year 3 Year 4 1*1.10 1*1.1^2 1*1.1^3 1*1.1^3 *1.05 To find the terminal value of the growth after year 4 we use the following equation: PV(n-1) = Div1/(Rs-Growth) year 1 year 2 year 3 year 4 CF 1.1 1.21 1.331 1.3975 PV CF1/(1+rs)^1, CF2/(1+rs)^2, CF3/(1+rs)^3, (CF4/(rs-0.05))/(1+rs)^3 Since the price is equal to 15 the sum of the PV values have to add to 15 Set excel to solve for the sum of those functions to be equal to 15 by changing the value of rs. Rs = 0.1297 or ~13%

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