Question

16) (6 pts) You estimate that Company DD's EPS will be $8 next year and $9 in Year 2. You also expect the stock will sell for $165 at the end of 2 years. You estimate the company will have a 40% dividend payout ratio. a) What is the implied ttm P/E multiple you are estimating the Co. DD will sell for at the end of year 2? Year 2 Implied ttm P/E multiple = b) What are your estimates for dividends over the next 2 years? Div. yr. 1 - Div.yr. 2 = c) What is the price you would be willing to pay (intrinsic value) for the stock today if you have a required rate of return of 7%? Your estimate of stock price today = $_

Answer 1

(a). It is given here that EPS for year 2 is expected to be $9

and expected market price of the stock at the end of year 2 will be $165.

P/E multiple = EPS/Current market price(for year 2)

P/E= $9/$165 = 0.054

(b). It is given in the question that the dividend payout ratio will be expected as 40%.

Dividend for year1 = 0.4 * (EPS for year 1)

D1 = 0.4*$8 = $3.2 per share.

Similarly, dividend for year2 = 0.4*$9 = $3.6

(c). Intrinsic value of a stock = dividend per share / (required rate of return - growth rate)

so, first we need to calculate the dividend growth rate from year 1 to year 2 = (year2-year1)/year1

dividend growth (g) = ($3.6 - $3.2)/$3.2 = 0.4/3.2 = 0.125 or 12.5%

Now, intrinsic value of stock = $3.2 / (0.07 - 0.125) = $58.18.

There is another method of calculation by considering time value of money.

Price of stock today = after 2 year price * PV factor @ 7%

Price of stock = $165 * 0.8734 = $144.11

But this price doesnot consider the dividend growth over two years.