You want to value a firm which is growing fairly fast now (abnormal growth) but will begin reaching maturity and a correspondingly lower earnings growth rate shortly. You’ve decided that a three-stage dividend discount model fits your needs perfectly for this firm. Using the information below, calculate the present value of this firm.

Earnings last year (E0) = $2.95 per share               Dividends last year (D0) = $0.60

ROE last year = 25%                                  growth = retention rate x ROE             

You expect earnings growth, dividend payout and ROE to be stable over the next two years. At that time we will see the firm slow its earnings growth, increase its dividend payout, and reduce its cost of equity over the next three years.

The long-term Treasury rate is 4%, the firm’s current beta is 1.4, but you expect the long-term beta to fall to 1.0 by the end of your phase down period and the market risk premium is 6%.

Long-term earnings are expected to grow at three percent to perpetuity and firm should be able to maintain a constant ROE of 10% for perpetuity.

What is the present value of this firm’s equity using the three-stage dividend discount model?