In practice, a common way to value a share of stock when a company pays dividend
ID: 2775087 • 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 $1.40. The dividends are expected to grow at 14 percent over the next five years. In five years, the estimated payout ratio is 40 percent and the benchmark PE ratio is 26.
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 12 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 $1.40. The dividends are expected to grow at 14 percent over the next five years. In five years, the estimated payout ratio is 40 percent and the benchmark PE ratio is 26.
Explanation / Answer
Solution:
Current Dividends 1.4 Dividend Growth for 5 years 14% Payout Ratio 40% Bechmark PE 26 Required Rate 12% Year Dividend = initial dividend * ( 1 + growth rate) ^ number of years 1 1.60 2 1.82 3 2.07 4 2.36 5 2.70 EPS in year 5 = Dividend in year 5 / Payout Ratio 6.74 Stock Price = EPS in year 5 * Benchmark PE $ 175.21