In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the ne...

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In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the next fiv

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Answer 1

Answer #1

Requirement (a). Target stock price in five years

Target stock price in five years = Earnings per share (EPS) in Year 5 x Benchmark P/E Ratio

Earnings per share (EPS) in Year 5 = D5 / Pay-out Ratio

Dividend per share in Year 0 (D0) = $1.18 per share

Dividend per share in Year 1 (D1) = $1.3334 per share [$1.18 x 113%]

Dividend per share in Year 2 (D2) = $1.5067 per share [$1.3334 x 113%]

Dividend per share in Year 3 (D3) = $1.7026 per share [$1.5067 x 113%]

Dividend per share in Year 4 (D4) = $1.9240 per share [$1.7026 x 113%]

Dividend per share in Year 5 (D5) = $2.1741 per share [$1.9240 x 113%]

Earnings per share (EPS) in Year 5 = D5 / Pay-out Ratio

= $2.1741 per share / 0.45

= $4.8313 per share

Target stock price in five years = Earnings per share (EPS) in Year 5 x Benchmark P/E Ratio

= $4.8313 per share x 20 Times

= $96.63 per share

“Hence, Target stock price in five years will be $96.63”

Requirement (b) - Stock price today

The stock price today is the aggregate of present value of future dividends and the price at the end of 5^th year

Year	Cash flow ($)	Present Value factor at 13.00%	Stock price ($)

1	1.3334	0.88496	1.18
2	1.5067	0.78315	1.18
3	1.7026	0.69305	1.18
4	1.9240	0.61332	1.18
5	2.1741	0.54276	1.18
5	96.63	0.54276	52.44

TOTAL			58.34

“Hence, the Stock price today will be $58.34”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)ⁿ], Where “r” is the Discount/Interest Rate and “n” is the number of years.

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