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

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    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.

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    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.