Chapter 9
Valuing Stocks
I. Chapter Outline
The following chapter outline is correlated to the PowerPoint Lecture Slides. The PowerPoint slides
are referenced in bold. Alternative Examples to selected textbook examples are also available in the
PowerPoint Lecture Slides and are also referenced in bold.
9.1 The Dividend-Discount Model (Slide 9)
• A One-Year Investor (Slides 9–10)
9.2 Applying the Dividend-Discount Model (Slide 19)
• Constant Dividend Growth (Slides 19–20)
• Example 9.2 Valuing a Firm with Constant Dividend Growth (Slides 21–22)
• PowerPoint Alternative Example 9.2 (Slides 23–24)
• Example 9.3 Cutting Dividends for Profitable Growth (Slides 31–32)
• Example 9.4 Unprofitable Growth (Slides 33–34)
9.3 Total Payout and Free Cash Flow Valuation Models (Slide 44)
• Share Repurchases and the Total Payout Model (Slides 44–46)
• Example 9.6 Valuation with Share Repurchases (Slides 47–48)
• PowerPoint Alternative Example 9.6 (Slides 49–50)
• The Discounted Free Cash Flow Model (Slides 51–54, 60)
– Valuing the Enterprise (Slide 52)
36 Berk/DeMarzo • Corporate Finance, Fourth Edition
• Example 9.8 Sensitivity Analysis for Stock Valuation (Slides 61–62)
• Figure 9.1 A Comparison of Discounted Cash Flow Models of Stock Valuation (Slide 63)
9.4 Valuation Based on Comparable Firms (Slide 64)
• Valuation Multiples (Slides 65–67, 72, 77)
– The Price-Earnings Ratio (Slides 65–67)
• Example 9.9 Valuation Using the Price-Earnings Ratio (Slides 68–69)
• PowerPoint Alternative Example 9.9 (Slides 70–71)
9.5 Information, Competition, and Stock Prices (Slide 83)
• Figure 9.3 The Valuation Triad (Slide 84)
• Information in Stock Prices (Slide 85)
• Example 9.11 Using the Information in Market Prices (Slides 86–87)
• PowerPoint Alternative Example 9.11 (Slides 88–90)
• Competition and Efficient Markets (Slides 91-92, 95-96)
II. Learning Objectives
9-1 Describe, in words, value for a common stock according to the Law of One Price, including the
discount rate that should be used.
9-2 Calculate the total return of a stock, given the dividend payment, the current price, and the
previous price.
9-3 Use the dividend-discount model to compute the value of a dividend-paying company’s stock,
whether the dividends grow at a constant rate starting now or at some time in the future.
Berk/DeMarzo • Corporate Finance, Fourth Edition 37
9-5 Given the retention rate and the return on new investment, calculate the growth rate in
dividends, earnings, and share price.
9-6 Describe circumstances in which cutting the firm’s dividend will raise the stock price.
9-7 Assuming a firm has a long-term constant growth rate after time N + 1, use the constant growth
model to calculate the terminal value of the stock at time N.
9-8 Compute the stock value of a firm that pays dividends as well as repurchasing shares.
9-9 Use the discounted free cash flow model to calculate the value of stock in a company with
leverage.
9-10 Use comparable firm multiples to estimate stock value.
III. Chapter Overview
This chapter shows how to use the Law of One Price to compute the value of a stock. The chapter
9.1 The Dividend-Discount Model
The authors begin by showing that a one-period investor will be willing to pay the same price as a
9.2 Applying the Dividend-Discount Model
The section begins with the assumption that dividends will grow at a constant rate. The constant
dividend growth model is given in equation 9.6. In the next equation (9.7), they solve for the equity
cost of capital, to show that the constant growth model assumes that dividends grow at the same rate
as the share price.
Because g is the same for share price as it is for dividends, the firm must increase its dividend in
order for the stock price to increase. Dividends can be increased in three ways: (1) increase earnings,
38 Berk/DeMarzo • Corporate Finance, Fourth Edition
9.3 Total Payout and Free Cash Flow Valuation Models
The total payout method uses the present value of the dividends paid, plus share repurchase amounts
divided by the number of shares outstanding, to compute share value.
The discounted free cash flow model begins by estimating the firm’s enterprise value as defined
in Chapter 2 and repeated in equation 9.17. To estimate the value of the firm’s equity, we begin with
9.4 Valuation Based on Comparable Firms
The use of comparables analysis is also based on the Law of One Price because a new firm that is
identical to an existing publicly traded company should be priced the same. The multiples discussed
9.5 Information, Competition, and Stock Prices
The first part of this section discusses the fact that the only way that two investors will come up with
an identical value for a given stock is if they both use the same inputs and valuation method. This
seldom happens, but with many transactions occurring every day on the stock market, a market price
is agreed upon.
The idea that competition among investors works to eliminate all positive-NPV trading
opportunities is introduced in this section. If new information becomes available, its impact depends
on whether the information is public and easily interpretable, private, or difficult to interpret. If the
Berk/DeMarzo • Corporate Finance, Fourth Edition 39
IV. Spreadsheet Solutions in Excel
The following Problems for Chapter 9 have spreadsheet versions of the problems available: 19,