Question

Question 1 Stock Valuation Apple and Pear, Inc earned $6 EPS and paid out 60% of earnings as dividends this year. Investors are optimistic about the prospects for Apple and Pear, Inc and are forecasting that dividend would grow over the next 5 years by about 7% a year. After year 5, growth will gradually settle down to a sustainable rate as 3% a year. The require rate of return of Apple and Pear as 6%. What is the current price of Apple and Pear, Inc.? Demonstrate using a timeline. Show all formulas and work.

Hint: 1. Value the firm’s dividends over the period of rapid growth. 2. Estimate Apple and Pear, Inc stock price at end of year 5, when growth should have settled down. 3. Calculate the present value of Apple and Pear, Inc stock by summing the present value of dividends up to the horizon year and the present value of the stock price at the horizon.

Answer 1

Price of stock = present value of next 5 years dividend + present value of terminal value at end of 5 years

Terminal value at end of 5 years = Year 5 dividend * (1 + growth rate after 5 years) / (required return - growth rate after 5 years)

Current dividend = EPS * payout ratio = $6 * 60% = $3.60

Present value = future value / (1 + required return)number of years

The price of stock today = $148.06

The price of stock today = $148.06