Question

2) (4 pts) You estimate that Company X will have earnings per share (EPS) of $4.00 next year (end of 2020) and EPS of $4.80 in 2 years (2021). You also estimate that Company X will sell at a P/E multiple of 23 in two years. The dividend payout ratio is expected to be 40%. a) What is your estimation of the intrinsic value of Company X if your required rate of return is 8.0% 2020 2021 Dividends Selling Price Intrinsic Value today = $. b) If Co. X is currently trading at $75, would you consider the stock a good buy today?_Yes or No_ More on back

Answer 1

1) Dividend payout ratio = 40%

Retention ratio = 100- dividend payout ratio

= 100-40 = 60%

P/E ratio = 23 (in two years)

MPS/EPS= 23

MPS/4.8 = 23

MPS = 110.4

EPS = 110.4*8%

= 8.832

Dividend= 8.832*40%

D1 = 3.5328

Rate of return (r) =8%

Retention ratio (b) =60%

g= b*r = 60%*8% = 4.8%

Intrinsic value = D1/r-g

= 3.5328/8%-4.8%

= 110.4

Dividend (2020)= EPS(2020)*40% =4*40% =1.6

Dividend (2021) = EPS (2021)*40% = 4.8*40%= 1.92

Alternatively: intrinsic value = d (2021)/r-g

= 1.92/8%-4.8% = 60

2) Actual stock price = 75

Market Price = 110.4

Actual stock price is lower, hence undervalued so co. can purchase.

Alternative:

Actual stock price = 75

Market price = 60

Here actual stock price is higher, so overvalued and hence company cannot buy.

*Alternative answer is more appropriate