Question

Suppose that a firm’s recent earnings per share and dividend per share are $2.70 and $1.70, respectively. Both are expected to grow at 9 percent. However, the firm’s current P/E ratio of 18 seems high for this growth rate. The P/E ratio is expected to fall to 14 within five years. Compute the dividends over the next five years. Compute the value of this stock price in five years Calculate the present value of these cash flows using an 11 percent discount rate

Answer #1

Answer a.

Recent Dividend, D0 = $1.70

Growth rate, g = 9%

D1 = $1.7000 * 1.09 = $1.8530

D2 = $1.8530 * 1.09 = $2.0198

D3 = $2.0198 * 1.09 = $2.2015

D4 = $2.2015 * 1.09 = $2.3997

D5 = $2.3997 * 1.09 = $2.6157

Answer b.

Current EPS, EPS0 = $2.70

Growth rate, g = 9%

EPS5 = EPS0 * (1 + g)^5

EPS5 = $2.7000 * 1.09^5

EPS5 = $4.1543

P/E Ratio = 14

P/E Ratio = P5 / EPS5

14 = P5 / $4.1543

P5 = $58.1602

Answer c.

Discount Rate = 11%

P0 = $1.8530/1.11 + $2.0198/1.11^2 + $2.2015/1.11^3 +
$2.3997/1.11^4 + $2.6157/1.11^5 + $58.1602/1.15^5

P0 = $36.97

So, present value of these cash flow is $36.97

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