Talisman pays semiannual dividends. The total dividends during 2006, 2007, and 2008 have been $0.114, $0.15, and $0.175, respectively. These imply a growth rate of 32 percent in 2007 and 17 percent in 2008. Yu believes that the growth rate will be 14 percent in the next year. He has estimated that the first stage will include the next eight years. Yu is using the CAPM to estimate the required return on equity for Talisman. He has estimated that the beta of Talisman, as measured against the S&P 500 Index is 0.84. The risk-free rate, as measured by the annual yield on the 10-year government bond, is 4.1 percent. The equity risk premium for the U. S. market is estimated at 5.5 percent. Based on these data, Yu is doing the analysis in January 2009 and the stock price at that time is $17.
Yu realizes that even within the two-stage DDM, there could be some variations in the approach. He would like to explore how these variations affect the valuation of the stock. Specifically, he wants to estimate the value of the stock for each of the following approaches separately/
1. The dividend growth rate will be 14 percent throughout the first stage of eight years. The dividend growth rate thereafter will be 7 percent.
2. Instead of using the estimated stable growth rate of 7 percent in the second stage, Dobson wants to use his estimate that eight years later Talisman’s stock will be worth 17 times its earnings per share (trailing P/E of 17). He expects that the earnings retention ratio at that time will be 0.70.
3. In contrast to the first approach above in which the growth rate declines abruptly from 14 percent in the eighth year to 7 percent in the ninth, the growth rate would decline linearly from 14 percent in the first year to 7 percent in the ninth.
Question:
Given the information in Question #1, use the third approach to estimate the stock price.
Based on your analysis, you should recommend that SWE buy this stock.
A. True
B. False