This year, Shoreline Light and Gas (SL&G) paid its stockholders an annual dividend of $3 a share. A major brokerage firm recently put out a report on SL&G stating that, in its opinion, the company’s annual dividends should grow at the rate of 10% per year for each of the next 5 years and then level off and grow at the rate of 6% a year thereafter.
a. Use the variable-growth DVM and a required rate of return of 12% to find the max-imum price you should be willing to pay for this stock.
b. Redo the SL&G problem in part a, this time assuming that after year 5, dividends stop growing altogether (for year 6 and beyond, g = 0). Use all the other information given to find the stock’s intrinsic value.
c. Contrast your two answers and comment on your findings. How important is growth to this valuation model?