2.10 In the spring of 1999, the pricing of Internet companies was a matter of debate among finance practitioners and academics alike. Take the case of AOL, which on April 22, 1999 closed at

$148.6875, consensus had a next-year earnings estimate of $0.53 per share, forward P/E =

281, and 49.5% annual nominal earnings growth for the next 5 years. Assume that AOL’s annual growth was expected to decrease to 28% during the following 5 years and then to settle down to the average long-term growth of 8%. AOL’s 5-year growth consensus was about 2% higher than the long-term nominal growth of earnings forecasted at that time for the S&P 500 as a whole. In addition, assume that after 10 years AOL was expected to start a 51% dividend payout (about the same as the long-term average of the S&P 500). Value AOL share’s by discounting future dividends. Assume a cost of equity of 10%. Interpret your results. How many times would AOL need to grow its real earnings over 10 years to justify your result? Assume 2.5% annual inflation.