This year, Shoreline Light and Gas (SL&G) paid its stockholders an annual dividend of $3.00 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 6% a year thereafter.
(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 12% 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,
g equals 0g=0).
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?