Question

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 $1.30. The dividends are expected to grow at 12 percent over the next five years. In five years, the estimated payout ratio is 34 percent and the benchmark PE ratio is 24.

What is the target stock price in five years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Target stock price $ What is the stock price today assuming a required return of 11 percent on this stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Stock price $

Answer #1

Annual dividends with 12% growth are

Year | Dividend |

1 | $ 1.46 |

2 | $ 1.63 |

3 | $ 1.83 |

4 | $ 2.05 |

5 | $ 2.29 |

EPS in year 5= D5/ Payout ratio = 2.29/34%

= 6.74

Price in year 5= PE Ratio* EPS

= 24*6.74 = 161.72

TARGET STOCK PRICE in 5 years= $161.76

Present value = 1.46/1.11 + 1.63/1.11^2 + 1.83/1.11^3 + 2.05/1.11^4 + (2.29+161.72)/1.11^5

102.65

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