Question

Problem 8-25 P/E Ratio Model and Future Price (LG8-7) Kellogg Co. (K) recently earned a profit of $2.52 earnings per share and has a P/E ratio of 13.5. The dividend has been growing at a 5 percent rate over the past few years. If this growth rate continues, what would be the stock price in five years if the P/E ratio remained unchanged? What would the price be if the P/E ratio declined to 12 in five years? (Round your answers to 2 decimal places.) Answer is complete but not entirely correct. Stock price Stock price with new P/E $ $ 3.22 38.64

Answer 1

Current Earnings (E0)=   2.52  
Growth rate of EPS=   5%  
Years (n)=   5  
Earnings in 5 year = E0*(1+g)^n      
2.52*(1+5%)^5      
3.216229538      
a. PE ratio =   13.5  
Stock Price = Earnings in 5th Year*PE ratio       
3.216229538   *13.5  
43.41909876      
      
So stock price with Current PE is   $43.42  
      
b. PE ratio =   12  
Stock Price = Earnings in 5th Year*PE ratio      
3.216229538   *12  

=38.59475446      
So stock price with new PE is   $38.59  

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