Question

If you look at stock prices over any year, you will find a high and low stock price for the year. Instead of a single benchmark PE ratio, we now have a high and low PE ratio for each year. We can use these ratios to calculate a high and a low stock price for the next year. Suppose we have the following information on a particular company over the past four years:

	Year 1				Year 2				Year 3				Year 4
High price	$	98.60			$	122.20			$	131.60			$	148.23
Low price		73.43				89.54				70.22				116.75
EPS		7.88				9.63				10.71				12.10

  

Earnings are projected to grow at 4 percent over the next year.

a.	What is your high target stock price over the next year? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b.	What is your low target stock price over the next year? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Computation of earnings per share for next year.

Current year EPS = $ 12.10

Growth rate = 4%

Next year EPS = Current year EPS x (1+growth rate)

Next year EPS = 12.10(1.04) = $ 12.584

Computation of the high PE ratio and low PE ratio for each year.

PE ratio = Stock price / EPS

Year		High PE Ratio		Low PE Ratio
1	98.60/7.88	12.512	73.43/7.88	9.318
2	122.20/9.63	12.689	89.54/9.63	9.298
3	131.60/10.71	12.287	70.22/10.71	6.556
4	148.23/12.10	12.250	116.75/12.10	9.648
	Total	49.738		34.82

Computation of average high PE ratio and average low PE ratio.

Average high PE ratio = 49.738/ 4 = 12.434

Average low PE ratio = 34.82/4 = 8.705

(a) Computation of high target stock price over the next year.

High target stock price = Average high PE ratio x Expected EPS for next year

High target stock price = 12.434 x 12.584 = $ 156.46

(b) Computation of low target stock price over the next year.We have,

Low target stock price = Average low PE ratio x Expected EPS for next year

Low target stock price = 8.705 x 12.584 = $ 109.54