Question

# In practice, a common way to value a share of stock when a company pays dividends...

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

 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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