Question

Assume Highline Company has just paid an annual dividend of $0.99. Analysts are predicting an 11.6% per year growth rate in earnings over the next five years. After​ then, Highline's earnings are expected to grow at the current industry average of 5.3% per year. If​ Highline's equity cost of capital is 7.9% per year and its dividend payout ratio remains​ constant, for what price does the​ dividend-discount model predict Highline stock should​ sell?

Answer 1

Since dividend payout is constant, dividend growth is approximated by earnings growth.

Using two-stage DDM model,

Stock price ($) = [D1 / (1 + r)] + [D2 / (1 + r)2] + [D3 / (1 + r)3] + [D4 / (1 + r)4] + [D5 / (1 + r)5] + [{D5 x (1 + g2) / (r - g2)} / (1 + r)5]

= [(0.99 x 1.116) / (1.079)] + [{0.99 x (1.116)2} / (1.079)2] + [{0.99 x (1.116)3} / (1.079)3] + [{0.99 x (1.116)4} / (1.079)4] + [{0.99 x (1.116)5} / (1.079)5] + [{0.99 x (1.116)5 x 1.053 / (0.079 - 0.053)} / (1.079)5]

= 1.02 + 1.06 + 1.10 + 1.13 + 1.17 + [{1.8046 / 0.026} / (1.079)5]

= 5.48 + [69.4077 / (1.079)5]

= 5.48 + 47.46

= 52.94