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 $1.36. The dividends are expected to grow at 13 percent over the next five years. In five years, the estimated payout ratio is 40 percent and the benchmark PE ratio is 19. |
a. | 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.) |
b. | 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.) |
Answer a.
Last Dividend, D0 = $1.36
Growth rate for next 5 years = 13%
D1 = $1.3600 * 1.13 = $1.5368
D2 = $1.5368 * 1.13 = $1.7366
D3 = $1.7366 * 1.13 = $1.9624
D4 = $1.9624 * 1.13 = $2.2175
D5 = $2.2175 * 1.13 = $2.5058
EPS5 * Payout Ratio = D5
EPS5 * 0.40 = $2.5058
EPS5 = $6.2644
P5 = EPS5 * PE Ratio
P5 = $6.2644 * 19
P5 = $119.02
Target price in five years, P5 = $119.02
Answer b.
Required Return = 11%
P0 = $1.5368/1.11 + $1.7366/1.11^2 + $1.9624/1.11^3 +
$2.2175/1.11^4 + $2.5058/1.11^5 + $119.02/1.11^5
P0 = $77.81
Stock price today, P0 = $77.81
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