In practice, a common way to value a share of stock when a company pays dividends...

In practice, a common way to value a share of stock when a company pays dividends is to value the dividends over the next seven years or so, then find the “terminal” stock price using a benchmark PE ratio. Suppose a company just paid a dividend of $3.50. The dividends are expected to grow at 8 percent over the next seven years. The company has a payout ratio of 35 percent and a benchmark PE of 45. What is the target stock price in seven years? What is the stock price today assuming a required return of 12 percent on this stock?

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Expert Solution

Price of Stock = PV of CFs from it.

Div Calc:

Year	CF	Formula	Calculation
1	$ 3.78	D0(1+g)	3.5*1.08
2	$ 4.08	D1(1+g)	3.78*1.08
3	$ 4.41	D2(1+g)	4.08*1.08
4	$ 4.76	D3(1+g)	4.41*1.08
5	$ 5.14	D4(1+g)	4.76*1.08
6	$ 5.55	D5(1+g)	5.14*1.08
7	$ 6.00	D6(1+g)	5.55*1.08

EPS7 = DPS7 / Payout Ratio

= $ 6 / 35%

= $ 17.14

P7 = EPS 7 * PE ratio

= $ 17.14 * 45

= $ 771.22

P0:

Year	CF	PVF @12%	Disc CF
1	$ 3.78	0.8929	$ 3.38
2	$ 4.08	0.7972	$ 3.25
3	$ 4.41	0.7118	$ 3.14
4	$ 4.76	0.6355	$ 3.03
5	$ 5.14	0.5674	$ 2.92
6	$ 5.55	0.5066	$ 2.81
7	$ 6.00	0.4523	$ 2.71
7	$ 771.22	0.4523	$ 348.86
Price of Stock			$ 370.10

jeff jeffy answered 1 week ago

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