Question

Suppose that a firm’s recent earnings per share and dividend per share are $3.00 and $2.30, respectively. Both are expected to grow at 10 percent. However, the firm’s current P/E ratio of 24 seems high for this growth rate. The P/E ratio is expected to fall to 20 within five years.

Compute the dividends over the next five years. (Do not round intermediate calculations. Round your final answer to 3 decimal places.)

Dividends	Years
First year	$
Second year	$
Third year	$
Fourth year	$
Fifth year	$

Compute the value of this stock price in five years. (Do not round intermediate calculations. Round your final answer to 2 decimal places.

Stock price

$

Calculate the present value of these cash flows using a 12 percent discount rate. (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

Present value

$

Answer 1

Year	Dividend
1	$    2.530
2	$    2.783
3	$    3.061
4	$    3.367
5	$    3.704

Taking P/E ratio of 20 in 5 years:
Price of stock = 3.704*20=$74.08

Year	Dividend		DF	PV
1	$    2.530		0.892857143	$       2.26
2	$    2.783		0.797193878	$       2.22
3	$    3.061		0.711780248	$       2.18
4	$    3.367		0.635518078	$       2.14
5	$    3.704		0.567426856	$       2.10
	$    74.08		Present Value	$    10.90

This present value is cash flows excluding stock price. The question is not clear on exact cash flows, so I am also providing solution for assuming that stock is sold and cash flow is received:

Year	Dividend		DF	PV
1	$    2.530		0.892857143	$       2.26
2	$    2.783		0.797193878	$       2.22
3	$    3.061		0.711780248	$       2.18
4	$    3.367		0.635518078	$       2.14
5	$    3.704	$    74.08	0.567426856	$    44.14
	$    74.08		Present Value	$    52.94