Question

1- In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the next five years or so, then find the “terminal” stock price using a benchmark PE ratio. Suppose a company just paid a dividend of $1.15. The dividends are expected to grow at 10 percent over the next five years. The company has a payout ratio of 40 percent and a benchmark PE of 19. The required return is 11 percent

What is the stock price today if you plan to sell this stock at the end of the 5th year?

Hint:You receive dividends every year for 5 years and you receive cash by selling the stock in the 5th year at it terminal price which you need to compute using PE ratio. Discount all these cash flows back to today.

2- Romulan Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years because the firm needs to plow back its earnings to fuel growth. The company will then pay a dividend of $23 per share 10 years from today and will increase the dividend by 5 percent per year thereafter. If the required return on this stock is 12 percent, what is the current share price?

3- The stock price of Chekov Co. is $67. Investors require a return of 10.5 percent on similar stocks. If the company plans to pay a dividend of $4.25 next year, what growth rate is expected for the company’s stock price?

Answer 1