In 2006, some fundamental investors believed that Microsoft, after being overpriced in the stock market for many years, was now a firm to buy. Microsoft's shares traded at $27.20 on September 26, 2006, down from a peak of $60 (split-adjusted) in January 2000. Analysts' consensus earnings-per-share forecasts for Microsoft's 2007 and 2008 fiscal years were $1.44 and $1.67, respectively. A dividend of $0.40 per share was indicated for 2007.

a. In order to build in a margin of safety, fundamental investors think of value without growth. Value a Microsoft share using abnormal earnings growth (AEG) methods under the assumptions that AEG will remain at the forecasted 2008 level after 2008.

Use a 9 percent required return for equity investment in Microsoft. What does your calculation tell you about the market's forecast of growth in AEG after 2008?

b. Calculate the traded forward P/E ratio for Microsoft and also the forward P/E implied by your valuation. What is the normal forward P/E for Microsoft?

c. Calculate Microsoft's traded PEG ratio based on analysts' forecasts of earnings for fiscal years 2007 and 2008.