Suppose that a firm\'s recent earnings per share and dividend per share are $3.1

Question

Suppose that a firm's recent earnings per share and dividend per share are $3.10 and $2.10, respectively. Both are expected to grow at 7 percent. However, the firm's current P/E ratio of 30 seems high for this growth rate. The P/E ratio is expected to fall to 26 within five years. Compute the dividends over the next five years. (Do not round intermediate calculations. Round your final answer to 3 decimal places.) Dividends First year Second year Third year Fourth year Fifth year Compute the value of this stock in five years. (Do not round intermediate calculations. Round your final answer to 2 decimal places.) Stock price Calculate the present value of these cash flows using a 9 percent discount rate. Do not round intermediate calculations. Round your final answer to 2 decimal places.) Present value

Explanation / Answer

D1 = D0 x (1 + g) = 2.1 x 1.07 = 2.247

D2 = D1 x (1 +g) = 2.247 x 1.07 = 2.404 and so on...

Stock Price in year 5 = EPS5 x P/E = EPS0 x (1 + g)^5 x P/E = 3.1 x (1 + 7%)^5 x 26 = $113.05

Present Value = D1 / (1 + r) + D2 / (1 + r)^2 + ... + (D5 + P5) / (1 + r)^5

= 2.247 / 1.09 + 2.404 / 1.09^2 + ... + (2.945 + 113.05) / 1.09^5

= $83.41

Year Dividend 1 2.247 2 2.404 3 2.573 4 2.753 5 2.945

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