In practice, a common way to value a share of stock when a company pays dividend
ID: 2774785 • 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 $1.75. The dividends are expected to grow at 21 percent over the next five years. In five years, the estimated payout ratio is 35 percent and the benchmark PE ratio is 33.
What is the target stock price in five years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
What is the stock price today assuming a required return of 11.5 percent on this stock? (Do not round intermediate calculations and 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 $1.75. The dividends are expected to grow at 21 percent over the next five years. In five years, the estimated payout ratio is 35 percent and the benchmark PE ratio is 33.
Explanation / Answer
5th year dividend =4,54
payout ratio= 35%
PE ratio=33
Traget price in 5 years = (5th year dividend/payout ratio) * PEratio = 4.54/.35 * 33 = $ 427.97
Price of the stock today = PV of all dividends + PV of terminal value
reqired rate of return =11.5%
year dividend expected growth rate rate@11.5% PV 0 1.75 1.21 1.115 1.899103 1 1.75 1.4641 1.243225 2.06091 2 1.75 1.771561 1.386195875 2.236503 3 1.75 2.14358881 1.545608401 2.427057 4 1.75 2.59374246 1.723353367 2.633847 5 427.97 3.138428377 1.921539004 222.7225 stock price 233.9799