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 $1.21. The dividends are expected to grow at 16 percent over the next five years. The company has a payout ratio of 40 percent and a benchmark PE of 23. The required return is 12 percent.

(A) What are the projected dividends for each of the next five years? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g.,32.16).)
(B) What is the EPS in five years? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
(C) 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).)

Answer 1

The answer is:

A. Find the detailed calculation in the explanation section.

B. $6.33

C. $145.59/share

Step-by-step explanation:

A.

Current dividend paid is $1.21

Growth rate for the next 5 years is 16 percent.

Dividend per share in Year 1 = $1.40 per share [$1.21 x 1.16]

Dividend per share in Year 2 = $1. 62 per share [$1.40 x 1.16]

Dividend per share in Year 3 = $1.88 per share [$1.62 x 1.16]

Dividend per share in Year 4 = $2.18 per share [$1.88 x 1.16]

Dividend per share in Year 5 = $2.53 per share [$2.18 x 1.16]

B.

Earnings per share (EPS) in Year 5 = Dividend per share in year 5 / Pay-out Ratio

$2.53/0.4

=$6.33

C.

Target stock price in five years = EPS in Year 5 x Benchmark P/E Ratio

= $6.33 per share x 23times

= $145.59/share