Problem 3

Colgate-Palmolive Company has just paid an annual dividend of $0.96. Analysts are predicting an 11% per year growth rate in earnings over the next five years. After that, Colgates earnings are expected to grow at the current industry average of 5.2% per year. If Colgates equity cost of capital is 8.5% per year and its dividend payout ratio remains constant, what price does the dividend-discount model predict Colgate stock should sell for?

Problem 4

Assume it is the start of 2009, in the midst of the world economic crisis. Benchmark Metrics Inc. (BMI), an all-equity financed firm, just reported EPS of $5 per share for 2008. Despite the economic downturn, BMI is confident regarding its current investment opportunities. But due to the financial crisis, BMI does not wish to fund these investments externally. The Board has therefore decided to suspend its stock repurchase plan and cut its dividend to $1 per share (vs. almost $2 per share in 2007), and retain these funds instead. The firm has just paid the 2008 dividend, and BMI plans to keep its dividend at $1 per share in 2009 as well. In subsequent years, it expects its growth opportunities to slow, and it will still be able to fund its growth internally with a target 40 percent dividend payout ratio, and reinitiating its stock repurchase plan for a total payout rate of 60 percent. (All dividends and repurchases occur at the end of each year.)

Suppose BMIs existing operations will continue to generate the current level of earnings per share in the future. Assume further that the return on new investment is 15%, and that reinvestments will account for all future earnings growth (if any). Finally, assume BMIs equity cost of capital is 10%.

a.Estimate BMIs EPS in 2009 and 2010 (before any share repurchases).

b.What is the value of a share of BMI at the start of 2009?