You are an investment adviser. One of your clients approaches you for your advice on investing in equity shares of Alpha Company. You have collected the following data:
Earnings per share last year $3.00
Payout ratio 0.40
Return on equity 0.25 from year 1 to 5
Cost of equity capital 0.20
The company plans to increase the payout ratio to 60% after year 5. This payout ratio and the return on equity are expected to prevail till perpetuity.
Estimate the price of an equity share of this company using an appropriate dividend discount model and advise your client whether they should buy a share of the company.
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