Value one stock using the dividend discount model of stock valuation with two periods of constant growth (not the simple one period growth model). See chapter 18 of the textbook, the problems 18.4 and 18.17 we did in class, or problem 27(f) from the practice problems for Exam I for a review of this model. Make the following assumptions:
What value do you find for the stock today with the DDM? That is, what is the sum of : the present value of D_{1} + the present value of D_{2} + the present value of D_{3} + the present value of D_{4} + the present value of D_{5} + the present value of V_{5}? The sum of these will be your stock value estimate today, V_{0}. How does V_{0} compare with the current stock price? Unless it's an amazing coincidence, these two values will be different. Does what you find imply that this stock would be a "buy" or a "sell" recommendation? Why? By what percent is the value you find with the DDM above or below the current market price? If your answer is outside of the range of +/- 5% of the current market price (not unlikely), continue with the next part.
Suppose now that you want to "prove" that the market price is correct. Change ONE of the following 3 assumptions until you can get your valuation to "equal" the current market price*: (1) the assumed [E(r_{M}) - r_{F}] value (make it higher or lower than 0.06 as needed), OR (2) the 5-year assumption of the first stage of growth (make it higher or lower than 5 years as needed), OR (3) the constant growth rate after 5 years (i.e., make it higher or lower than 0.03 as needed). You will be able to make it work (after some trial and error--use Excel!) by changing ONE of these.
When you get an answer that is within +/- 5% of the current market price this is close enough to say "equal to" the current market price.
Summarize all of your answers and calculations to the parts above in a spreadsheet.