To give you some direction, your boss has told you that he wants you to apply a three-stage Dividend Discount Model. In this model the key ingredients are: k, the cost of equity/required rate of return; g, the growth rate in dividends; and D, the dividend.
To estimate the cost of equity, k, your boss has provided you with 5 years of monthly data and suggests you use the CAPM to estimate the historical beta. Once you have estimated the beta, you can compute the expected cost of equity. To do this your boss suggests that you use a risk-free rate of3% and a market risk premium of 7.5%.
To determine the growth rate of dividends your boss suggests the following approach. For the years 2014-2016 you assume that dividends will grow at the historical dividend growth rate for the period from 2006 to 2013. From 2017 – 2019 the dividend growth rate will increase by 2% p.a. From 2019 onwards dividends will grow at a constant rate of 7% p.a.
Use the dividend discount model to determine a fundamental value for Sky TV’s stock price. Given that the current price of Sky TV is $6.52, what is your recommendation?
