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 $1.18. The dividends are expected to grow at 13 percent over the next five years. The company has a payout ratio of 45 percent and a benchmark PE of 20. The required return is 13 percent.

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 price in 5 years
$

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

Stock price today

Answer #1

Dividend | |||||

Year | Dividend | ||||

1 | 1.18 +13% = | 1.3334 | |||

2 | 1.3334+13% = | 1.51 | |||

3 | 1.51+13% = | 1.71 | |||

4 | 1.71+13% = | 1.93 | |||

5 | 1.93+13% = | 2.18 | |||

Dividend at the end of Year-5 is 2.18 | |||||

Earnings per share at end of Year-5 =2.18 /45 *100 = 4.84 | |||||

PE ratio =20 | |||||

PE ratio = Market price/ Earnings per share | |||||

20 = Market price / 4.84 | |||||

Market price = 96.8 | |||||

Stock price at end of 5 yrs =96.8 | |||||

Req b: | |||||

Stock price today | |||||

Year. | Cashflows | PVF at 13% | Present values | ||

1 | 1.33 | 0.884956 | 1.176991 | ||

2 | 1.51 | 0.783147 | 1.182551 | ||

3 | 1.71 | 0.69305 | 1.185116 | ||

4 | 1.93 | 0.613319 | 1.183705 | ||

5 | 2.18 | 0.54276 | 1.183217 | ||

5 | 96.8 | 0.54276 | 52.53917 | ||

Present value of cashflows | 58.45 | ||||

Stockprice today = 58.45 per share | |||||

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