In practice, a common way to value a share of stock when a company pays dividend
ID: 2492212 • Letter: I
Question
In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the next five years or so, then find the “terminal” stock price using a benchmark PE ratio. Suppose a company just paid a dividend of $2.15. The dividends are expected to grow at 16 percent over the next five years. In five years, the estimated payout ratio is 35 percent and the benchmark PE ratio is 41.
What is the target stock price in five years? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Target stock price $
What is the stock price today assuming a required return of 15.5 percent on this stock? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Stock price $
Explanation / Answer
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Dividend just paid =D0= 2.15 Expected dividends with 16% growth rate= 2.49 2.89 3.36 3.89 4.52 Estimated payout ratio=35% Earning per share at Year 5 =4.52/35%=12.90 PE ratio benchmark 41 So Price per share at Year 5 =41*12.90=$528.99 So Stock price at Year 5=$528.99 When required return of stock =15.5% Price of the stock today =528.99/1.155^5=257.36 So stock price today =$257.36