Highland Pet Supplies Company forecasts earnings per share of $2.50 during the coming year. Highland has always paid a dividend equal to 40 percent of its earn- ings, and it anticipates continuing this practice. Earnings are expected to increase at a rate of 20 percent per year in years 2 and 3, 15 percent in year 4, and 6 percent per year thereafter. The beta of Highland stock is 1.5, the risk-free rate is 7 percent, and the market risk premium has been estimated to be 8 percent.
a. What is the current (time 0) value of a share of Highland stock?
b. What value would you project for a share of stock at the beginning of year 3?