Question

Fowler is expected to pay a dividend of $1.61 one year from today and $1.76 two years from today. The company has a dividend payout ratio of 40 percent and the PE ratio is 17.95 times. If the required return on the company's stock is 10.9 percent, what is the current stock price?

Answer 1

Current Stock Price

The Current Price of the stock is the Present Value of the Future Dividends plus the present value of the share price in year 2 [P2]

Required Rate of Return (r) = 10.90%

Dividend in Year 1 (D1) = $1.61 per share

Dividend in Year 2 (D2) = $1.76 per share

Earnings per share in Year 2 = Dividend in Year 2 / Dividend Payout Ratio

= $1.76 / 0.40

= $4.40 per share

Share Price in Year 2 (P2) = EPS in Year 2 x P/E Ratio

= $4.40 per share x 17.95 Times

= $78.98 per share

Current Price of the stock

The Current Price of the stock is the Present Value of the Future Dividends plus the present value of the share price in year 2 [P2]

Current Price of the Stock (P0) = D1/(1 + r)¹ + D2/(1 + r)² + P2/(1 + r)²

= $1.61/(1 + 0.1090)¹ + $1.76/(1 + 0.1090)² + $78.98/(1 + 0.1090)²

= [$1.61 / 1.1090] + [$1.76 / 1.22988] + [$78.98 / 1.22988]

= $1.45 + $1.43 + $64.22

= $67.10 per share

“Hence, the Current Price of the stock would be $67.10 per share