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Evaluation of a company: three-stage dividend growth model with declining growth

I am evaluating a firm using the three-stage dividend growth model with a linearly declining growth rate in Stage 2. I am using the following information (as of the start of 2004):

* Current dividend is $0.39
* I estimate the required rate of return on the stock at 8.72%
* In stage 1, the dividend will grow at 11.3 percent annually for the next 5 years.
* In stage 2, which will last 10 years, the dividend growth rate will decline linearly, starting with the Stage 1 rate and ending at the stage 3 rate.
* The equilibrium long-term dividend growth rate (in Stage 3) will be 5.7 percent.

What is my valuation of this company? It is currently selling for $25 dollars.

Solution Preview

Please refer to the attachment.

K= 8.72%

Stage 1, we calculate the present values of the first 5 years' dividend,
(Please refer to the EXCEL for calculation.)
*note: from year 1-5, the dividend is growing at 11.3%;
and the discount rate is K=8.72%
year growth rate dividend PV of dividend
0 11.30% 0.39
1 11.30% 0.43 0.40
2 11.30% 0.48 0.41

Solution Summary

The solution provides all the calculations necessary to understand how to arrive at the answer, plus narrative explanation as needed.