Colgate-Palmolive Company has just paid an annual dividend of $1.50. Analysts are predicting dividends to grow by $0.12 per year over the next five years. After then, Colgate’s earnings are expected to grow 6% per year, and its dividend payout rate will remain constant. If Colgate’s equity cost of capital is 8.5% per year, what price does the dividend-discount model predict Colgate stock should sell for today?

$66.47

Explanation:

For computation of current value of stock first we need to follow some steps which is shown below:-

Present value of dividend of next 5 years

Year   Dividend    Discount factor    Present value

a              b               c = 1.085^-a           d = b × c

1             $1.62          0.921659              $1.49

2             $1.74         0.849455              $1.48

3            $1.86          0.782908             $1.46

4            $1.98           0.721574             $1.43

5            $2.10           0.665045           $1.40

Total                                                      $7.25

Present value after 5 years = D5 × (1 + g) ÷ (Ke - g) × DF5

= $2.10  × (1 + 6%) ÷ (8.50% - 6%) × 0.665045

= $59.22

as

D5 indicates Dividend of year 5 = $2.10

g = Growth rate = 6%

Ke = Required return = 8.50%

DF5Discount factor of year 5 = 1.085^-5 = 0.665045

Current value of stock = Present value of dividends

= $7.25 + $59.22

= $66.47

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