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

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In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the next fiv

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Answer 1

Answer #1

Requirement (a). Target stock price in five years

Target stock price in five years = Earnings per share (EPS) in Year 5 x Benchmark P/E Ratio

Earnings per share (EPS) in Year 5 = D5 / Pay-out Ratio

Dividend per share in Year 0 (D0) = $1.31 per share

Dividend per share in Year 1 (D1) = $1.5196 per share [$1.31 x 116%]

Dividend per share in Year 2 (D2) = $1.7627 per share [$1.5196 x 116%]

Dividend per share in Year 3 (D3) = $2.0448 per share [$1.7627 x 116%]

Dividend per share in Year 4 (D4) = $2.3719 per share [$2.0448 x 116%]

Dividend per share in Year 5 (D5) = $2.7514 per share [$2.3719 x 116%]

Earnings per share (EPS) in Year 5 = D5 / Pay-out Ratio

= $2.7514 per share / 0.30

= $9.1715 per share

Target stock price in five years = Earnings per share (EPS) in Year 5 x Benchmark P/E Ratio

= $9.1715 per share x 19 Times

= $174.26 per share

“Hence, Target stock price in five years will be $174.26”

Requirement (b) - Stock price today

The stock price today is the aggregate of present value of future dividends and the price at the end of 5^th year

Year	Cash flow ($)	Present Value factor at 14.00%	Stock price ($)

1	1.5196	0.87719	1.33
2	1.7627	0.76947	1.36
3	2.0448	0.67497	1.38
4	2.3719	0.59208	1.40
5	2.7514	0.51937	1.43
5	174.26	0.51937	90.50

TOTAL			97.41

“Hence, the Stock price today will be $97.41”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.

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