In the first approach, what proportion of the total value of the stock is represented by the value of the second stage?
A. 0.10
B. 0.52
C. 0.90

Assorted Fund, a UK - based globally diversified equity mutual fund, is considering adding Talisman Energy Inc. (Toronto Stock Exchange: TLM) to its portfolio. Talisman is an independent upstream oil and gas company headquartered in Calgary, Canada. It is one of the largest oil and gas companies in Canada and has operations in several countries. Brian Dobson, an analyst at the mutual fund, has been assigned the task of estimating a fair value of Talisman. Dobson is aware of several approaches that could be used for this purpose. After carefully considering the characteristics of the company and its competitors, he believes the company will have extraordinary growth for the next few years and normal growth thereafter. He has therefore concluded that a two - stage DDM is the most appropriate for valuing the stock.
Talisman pays semiannual dividends. The total dividends during 2006, 2007, and 2008 have been C $ 0.114, C $ 0.15, and C $ 0.175, respectively. These imply a growth rate of 32 percent in 2007 and 17 percent in 2008. Dobson believes that the growth rate will be 14 percent in the next year. He has estimated that the first stage will include the next eight years.
Dobson is using the CAPM to estimate the required return on equity for Talisman. He has estimated that the beta of Talisman, as measured against the S & P/TSX Composite Index (formerly TSE 300 Composite Index), is 0.84. The Canadian risk - free rate, as measured by the annual yield on the 10 - year government bond, is 4.1 percent. The equity risk premium for the Canadian market is estimated at 5.5 percent. Based on these data, Dobson has estimated that the required return on Talisman stock is 0.041 + 0.84(0.055) = 0.0872 or 8.72 percent. Dobson is doing the analysis in January 2008 and the stock price at that time is C $ 17.
Dobson realizes that even within the two - stage DDM, there could be some variations in the approach. He would like to explore how these variations affect the valuation of the stock. Specifically, he wants to estimate the value of the stock for each of the following approaches separately.
I. The dividend growth rate will be 14 percent throughout the first stage of eight years. The dividend growth rate thereafter will be 7 percent.
II. Instead of using the estimated stable growth rate of 7 percent in the second stage, Dobson wants to use his estimate that eight years later Talisman’s stock will be worth 17 times its earnings per share (trailing P/E of 17). He expects that the earnings retention ratio at that time will be 0.70.
III. In contrast to the first approach in which the growth rate declines abruptly from 14 percent in the eighth year to 7 percent in the ninth, the growth rate would decline linearly from 14 percent in the first year to 7 percent in the ninth.