Question

XYZ Company stock has been trading at about $27. You believe the market is assuming XYZ's modest 4% growth over the past several years and has not recognized that XYZ has new technology that will allow it to be first to market with several new products. Because of this you estimate the current EPS of $4.00 a share will grow at a 20% compound annual growth rate (CAGR) during the next 5 years. After that you think competition will probably catch up and company growth will return to 4%. Also, you note that management has announced it expects to maintain its current 50% dividend payout ratio indefinitely. If your required return is 18% what is your best estimate of XYZ's present stock value?

Answer 1

EPS	$         4.00
Dividend payout ratio	50%
Dividend payment	$         2.00
Year	Growth rate	Dividend computation	Dividend	PV factor @18%, 1/(1+r)^time	Dividend * PV factor
1	20.00%	2*(1+20%)	$     2.40	0.8475	$        2.03
2	20.00%	2.4*(1+20%)	$     2.88	0.7182	$        2.07
3	20.00%	2.88*(1+20%)	$     3.46	0.6086	$        2.10
4	20.00%	3.456*(1+20%)	$     4.15	0.5158	$        2.14
5	20.00%	4.1472*(1+20%)	$     4.98	0.4371	$        2.18
5			$   36.97	0.4371	$      16.16
				Share price	$      26.68
Current Dividend	$         4.98
Rate of return	18.00%
Growth Rate	4.00%
Share Price at horizon	=Current Dividend*(1+Growth rate)/(Rate of return-Growth Rate)
Share Price at horizon	=4.97664*(1+0.04)/(0.18-0.04)
Share Price at horizon	$       36.97