Question

Colgate-Palmolive Company has just paid an annual dividend of $ 1.69 . Analysts are predicting dividends to grow by $ 0.17 per year over the next five years. After​ then, Colgate's earnings are expected to grow 6.8 % per​ year, and its dividend payout rate will remain constant. If​ Colgate's equity cost of capital is 7.8 % per​ year, what price does the​ dividend-discount model predict Colgate stock should sell for​ today?

Answer 1

The dividend-discount model is used to estimate the value of a stock based on its future dividends. In the case of Colgate-Palmolive Company, the model predicts the price of the stock today based on its expected dividend growth rate and the equity cost of capital.

Step-by-step explanation:

The dividend-discount model is used to estimate the value of a stock based on its future dividends. In the case of Colgate-Palmolive Company, the dividend is expected to grow by $0.17 per year over the next five years. After that, its earnings are expected to grow at a rate of 6.8% per year, and the dividend payout rate will remain constant. With an equity cost of capital of 7.8% per year, we can calculate the price that the dividend-discount model predicts Colgate stock should sell for today.

First, we need to calculate the present value of the future dividends. Using the formula:

PV = D0 + (D1 / (1+r)) + (D2 / (1+r)^2) + ... + (Dn / (1+r)^n)

where PV is the present value, D is the dividend, r is the discount rate, and n is the number of years. Plugging in the given values, we get:

PV = $1.69 + ($1.69 + $0.17) / (1+0.078) + ($1.69 + 2*$0.17) / (1+0.078)^2 + ...

Solving this equation will give us the predicted price of Colgate stock today.