Question

Neil is evaluating a Parrott Inc using dividend discount model. He has analyzed past dividends, earnings per share and payout ratios and has summarized the following info: Most recent dividend was $1.94 per share Most recent EPS was $6.45 EPS growth is 8% per year Dividend payout is stable at 30% Beta is 2.3 Risk free rate is 1.8% Market risk premium is 6.1%. What is the fair price for this stock?

Answer 1

Solution:- Calculation of the Required Rate of Return (Re)

Re = Rf + (Rm-Rf)*Beta

Where, Rf = Risk free Return

(Rm-Rf) = Market Risk Premium

Therefore, Re= 1.8% + 6.1% * 2.3

Re = 15.83%

Calculation of fair price of Stock

Price = D1 / ( Re-g)

Where , D1 is the Next expected dividend

g is the Growth Rate

Re is the Required Rate of Return

D1 = Dividend * (1+growth)

=1.94 * 1.08 = 2.10 ,

or

= [Earnings * (1+growth)] * 30%

= [6.45 * 1.08)*30% = 2.10

Price = 2.10 / (15.83% - 8%)

= 2.10 / 7.83%

= $ 26.82