P12-43. Estimating Cost of Capital Measures and Applying the DDM Model Procter and Gamble Company has a June fiscal year-end. On June 30, 2006, analysts expected the company to pay $1.41 dividends per share in fiscal year 2007, and its market beta was estimated to be 0.7. Assume that the risk-free rate is 4.6% and the market premium is 5%. During fiscal year 2006, the company's sales growth was 20.2%. However, analysis reveals that P&G's fiscal 2006 sales include eight months of sales from Gillette after its acquisition by P&G during 2006. Footnotes report pro forma sales that show what the income statement would have reported had Gillette's full-year sales been included in both 2005 and 2006specifically, P&Gs sales growth would have been 4.4%. Required a. Estimate P&G's cost of equity capital using the CAPM model. b. Estimate P&Gs intrinsic value using the DDM assuming that dividends per share are projected at $1.41 per share after 2007. (Hint: Apply the DDM with constant perpetuity, shown on page 12-19.) c. Discuss the appropriateness of the estimate computed in part b in light of the DDM assumption of zero future dividend growth. d. If we use the Gordon Growth DDM to estimate stock value per share, which of the two growth rates should we use: 20.2% or 4.4%? Explain. e. On June 30, 2006, the stock of P&G was priced at $55.60 per share. Infer the market expectation about the future growth rate of P&Gs dividend using the DDM with an increasing perpetuity (Gordon growth DDM). Comment on the reasonableness of this inferred growth rate. P12-43. Estimating Cost of Capital Measures and Applying the DDM Model Procter and Gamble Company has a June fiscal year-end. On June 30, 2006, analysts expected the company to pay $1.41 dividends per share in fiscal year 2007, and its market beta was estimated to be 0.7. Assume that the risk-free rate is 4.6% and the market premium is 5%. During fiscal year 2006, the company's sales growth was 20.2%. However, analysis reveals that P&G's fiscal 2006 sales include eight months of sales from Gillette after its acquisition by P&G during 2006. Footnotes report pro forma sales that show what the income statement would have reported had Gillette's full-year sales been included in both 2005 and 2006specifically, P&Gs sales growth would have been 4.4%. Required a. Estimate P&G's cost of equity capital using the CAPM model. b. Estimate P&Gs intrinsic value using the DDM assuming that dividends per share are projected at $1.41 per share after 2007. (Hint: Apply the DDM with constant perpetuity, shown on page 12-19.) c. Discuss the appropriateness of the estimate computed in part b in light of the DDM assumption of zero future dividend growth. d. If we use the Gordon Growth DDM to estimate stock value per share, which of the two growth rates should we use: 20.2% or 4.4%? Explain. e. On June 30, 2006, the stock of P&G was priced at $55.60 per share. Infer the market expectation about the future growth rate of P&Gs dividend using the DDM with an increasing perpetuity (Gordon growth DDM). Comment on the reasonableness of this inferred growth rate
