Question

If you look at stock prices over any year, you will find a high and low stock price for the year. Instead of a single benchmark PE ratio, we now have a high and low PE ratio for each year. We can use these ratios to calculate a high and a low stock price for the next year. Suppose we have the following information on a particular company over the past four years: Year 1 Year 2 Year 3 Year 4   High price $ 98.70 $ 122.30 $ 131.70 $ 148.33   Low price 73.53 89.64 70.32 116.85   EPS 7.98 9.73 10.81 12.20    Earnings are projected to grow at 5 percent over the next year. What is your high target stock price over the next year? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)   High target stock price $    What is your low target stock price over the next year? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)   Low target stock price $

Answer 1

“(a). High target stock price over the next year = $157.82”

“(b). Low target stock price over the next year = $110.52”

Step-1, Earnings Per Share of the Next Year

EPS5 = EPS4[1 + g]

= $12.20[1 + 0.05]

= $12.81 per share

Step-2, Calculation of high target stock price over the next year

P/E Ratio = High Price / EPS

P/E1 = $98.70 / $7.98 = 12.37 Times

P/E2 = $122.30 / $9.73 = 12.57 Times

P/E3 = $131.70 / $10.81 = 12.18 Times

P/E4 = $148.33 / $12.20 = 12.16 Times

Average P/E Ratio = [12.37 + 12.57 + 12.18 + 12.16] / 4 = 12.32 Times

High target stock price over the next year = EPS5 x Average P/E Ratio

= $12.81 x 12.32 Times

= $157.82 per share

Step-3, Low target stock price over the next year

P/E Ratio = High Price / EPS

P/E1 = $73.53 / $7.98 = 9.21 Times

P/E2 = $89.64 / $9.73 = 9.21 Times

P/E3 = $70.32 / $10.81 = 6.51 Times

P/E4 = $116.85 / $12.20 = 9.58 Times

Average P/E Ratio = [9.21 + 9.21 + 6.51 + 9.58] / 4 = 8.63 Times

Low target stock price over the next year = EPS5 x Average P/E Ratio

= $12.81 x 8.63 Times

= $110.52 per share