This year, Shoreline Light and Gas (SL&G) paid its stockholders an annual dividend of $2.00 a share. A major brokerage firm recently put out a report on SL&G predicting that the company’s annual dividends should grow at the rate of 10 % per year for each of the next five years and then level off and grow at the rate of 5 % a year hereafter. (Note: Use four decimal places for all numbers in your intermediate calculations.)
a. Use the variable-growth DVM and a required rate of return of 11 % to find the maximum price you should be willing to pay for this stock.
b. Redo the SL&G problem in part a, this time assuming that after year 5, dividends stop growing altogether (for year 6 and beyond,
). Use all the other information given to find the stock’s intrinsic value.
c. Contrast your two answers and comment on your findings. How important is growth to this valuation model?