Question

1. Stock Valuation:

      

       Primrose Corporation is considering investing in Metro Corporation by purchasing 10,000 shares of the corporation’s stock. The Metro Corporation just paid a dividend of $1.15. The dividends are expected to grow at 10 percent over the next 5 years. The company has a payout ratio of 40 percent and an expected PE ratio of 21. Based on the company’s payout ratio, earnings per share in year 5 would be $4.64 (EPS₅ = D₅ / Payout ratio = $1.86 / .40 = $4.64).

1. What is the future (terminal value) stock price in five years? Show your work.

      

2. What is the stock price today assuming a required return of 11 percent on this stock? Show your work.

      

3. Assuming Primrose sells all $10,000 shares of stock at the end of the 5^th year, how much money will the company gain or lose? Show your work.

Answer 1

A)

Given Expected PE ratio = 21 times

EPS in 5 years =$ 4.64

Terminal Value of stock Price in 5 years = 21 * 4.64 = $ 97.44

B)

Using dividend discount model,

Los 1.302 1.15 1.392 2.531 1.531 1.684 1.85 Primrose Corporation Dividends EPS in 5th year Terminal Value Net Cash flows Required return Stock Price today 97.44 99.29 1.15 1.27 1.39 1.53 1.68 11% $63.42

Price of stock today = $ 63.42

C)

Profit per stock = (97.44 - 63.42) = $ 34.02

Total money gained for 10,000 shares = 34.02 * 10,000 = $ 340,200

Formulae

0.1 1.15 =C1071*(1+$B$1071) =D1071*(1+$B$1071) =E1071*(1+$B$1071) =F1071*(1+$B$1071) 1070 Primrose Corporation 1071 Dividends 1072 EPS in 5th year 1073 Terminal Value 1074 Net Cash flows 1075 Required return 1076 Stock Price today 4.64 21 =C1071+C1073 =D1071+D1073 =E1071+E1073 =F1071+F1073 =G1071+G1073 0.11 =NPV(B1075,D1074:H1074)