Question

This year, Bootle's Inc. just paid out a $1.15/share annual dividend. Analysts predict a 9.2% growth rate in earnings per year over the next 2 years, a 4.7% growth rate for the following year, and after that they expect earnings growth at the industry average of 4% forever. Comparable investments have a rate of return of 6%. If Bootle's Inc. expects to keep its dividend payout ratio constant, and only account for future earnings, what price should you expect to pay for the stock today?

Answer 1

The value of the stock is computed as follows:

= Dividend in year 1 / (1 + required rate of return)¹ + Dividend in year 2 / (1 + required rate of return)² + Dividend in year 3 / (1 + required rate of return)³ + 1 / (1 + required rate of return)³ [ ( Dividend in year 3 (1 + growth rate) / ( required rate of return - growth rate) ]

= ($ 1.15 x 1.092) / 1.06 + ($ 1.15 x 1.092²) / 1.06² + ($ 1.15 x 1.092² x 1.047) / 1.06³ + 1 / 1.06³ x [ ($ 1.15 x 1.092² x 1.047 x 1.04) / (0.06 - 0.04) ]

= $ 1.2558 / 1.06 + $ 1.3713336 / 1.06² + $ 1.435786279 / 1.06³ + 1 / 1.06³ x [ $ 74.66088652 ]

= $ 1.2558 / 1.06 + $ 1.3713336 / 1.06² + $ 76.0966728 / 1.06³

= $ 66.30