In practice, a common way to value a share of stock when a company pays dividend
ID: 2790230 • Letter: I
Question
In practice, a common way to value a share of stock when a company pays dividends is to value the the next five years. In five years, the estimated payout ratio is 34 percent and the benchmark PE ratio is 24. What is the target stock price in five years? (Do not round intermediate calculations and round your price using a benchmark PE ratio answer to 2 decimal places, e.g., 32.16 Target stock price What is the stock price today assuming a required return of 11 percent on this stock? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Stock priceExplanation / Answer
Answer a) First we need to find the dividend each year
1.30*(1+0.12) =1.456
1.30*(1+0.12)^2 =1.63072
1.30*(1+0.12)^3 =1.826406
1.30*(1+0.12)^4 =2.045575
1.30*(1+0.12)^5 =2.291044
In the year 5 we use the dividend and payout ratio
EPS = D5 / PAYOUT Ratio
= 2.291 / 0.34 =6.738365
Terminal stock price in year 5
Price in year 5 = eps in year 5 x benchmark pe ratio
= 24 x 6.738365 = 161.7208
Answer b)
Now the stock price today will be equal to
Price =
1.456 / 1.11 + 1.63072 / (1.11)^2 + 1.826406 / (1.11)^3 + 2.045575 / (1.11)^4 + (2.291044 + 161.7208) / (1.11)^5
Price = 102.6512