In practice, a common way to value a share of stock when a company pays dividend
ID: 2732937 • 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 $1.31. The dividends are expected to grow at 16 percent over the next five years. In five years, the estimated payout ratio is 30 percent and the benchmark PE ratio is 19. After five years, the earnings are expected to grow at 7 percent per year. The required return is 14 percent.
What is the target stock price in five years?(Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
What is the stock price today?(Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
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 $1.31. The dividends are expected to grow at 16 percent over the next five years. In five years, the estimated payout ratio is 30 percent and the benchmark PE ratio is 19. After five years, the earnings are expected to grow at 7 percent per year. The required return is 14 percent.
Explanation / Answer
1 Dividend payment estimations over next 5 years Current dividend 1.31 1st year dividend @ 16% growth 1.51 2nd year dividend 1.76 3rd year dividend 2.04 4th year dividend 2.36 5th year dividend 2.74 2 Estimated payout 30% 3 PE ratio 19 4 Earnings per share 70% 5th year 6.34 5 Price of the share after 5 years EPS * PE ratio 120.46 Valued by using benchmark PE ratio 6 Price as on today(dividend discounting model) 69.53 Yr Dividend Pv factor @14% Disc cash inflows 1 1.51 0.88 1.3288 2 1.76 0.77 1.3552 3 2.04 0.67 1.3668 4 2.36 0.60 1.416 5 2.74 0.52 1.4248 Terminal value 5 120.46 0.52 62.6392 Total 69.5308