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 $1.31. The dividends are expected to grow at 16 percent over the next five years. The company has a payout ratio of 30 percent and a benchmark PE of 19. The required return is 14 percent.
    
What are the projected dividends for each of the next five years? (Do not round intermediate calculations and round your answers to 2 decimal places, e.g.,32.16.)
  

	Dividend
Year 1	$
Year 2	$
Year 3	$
Year 4	$
Year 5	$

  
What is the EPS in five years? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g.,32.16.)
  
EPS in 5 years            $
  
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.)
  
Stock price in 5 years            $
  
What is the stock price today? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g.,32.16.)
  
Stock price today            $

Answer 1

(1)-Projected dividends for each of the next five years

Year	Dividend per share ($)
Year 1 [$1.31 x 116%]	1.52
Year 2 [$1.52 x 116%]	1.76
Year 3 [$1.76 x 116%]	2.04
Year 4 [$2.04 x 116%]	2.37
Year 5 [$2.37 x 116%]	2.75

(2)-EPS in five years

Dividend per share in year o (D0) = $1.31 per share

EPS in Year 0 = $4.3667 per share [$1.31 / 0.30]

EPS after 5 years = EPS x (1 + g) n

= $4.3667 x (1 + 0.16) 5

= $4.3667 x 2.1003

= $9.1715 per share

= $9.17

= $9.17 per share

“The EPS in five years = $9.17”

(3)-Target stock price in five years

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

= $9.1715 per share x 19 Times

= $174.26 per share

“The Target stock price in five years will be $174.26”

(4)-Stock price today

As per Dividend Discount Model, the Value of the Stock is the aggregate of the Present Value of the future dividend payments and the present value the stock price for the year 5

Year	Cash flow ($)	Present Value Factor (PVF) at 12.00%	Present Value of cash flows ($) [Cash flows x PVF]
1	1.52	0.87719	1.33
2	1.76	0.76947	1.36
3	2.04	0.67497	1.38
4	2.37	0.59208	1.40
5	2.75	0.51937	1.43
5	174.26	0.51937	90.50
TOTAL	97.41

“The Stock price today will be $97.41”

NOTE

The Formula for calculating the Present Value Factor is [1/(1 + r)n], Where “r” is the Discount/Interest Rate and “n” is the number of years.