Question

Plutarch Corp. has recently developed a new product which is the first of its kind. Plutarch expects this will give it a significant first mover advantage in the market and that is expected to provide growth in earnings per share of 400% within the coming year, and 75% growth in each of the subsequent 3 years. After that time, it is expected competitors will have developed and brought to market similar products with the result that Plutarch would expect earnings growth to drop back to its normal level of 3% per year forever. Plutarch's cash dividend was 10 cents per share last year and is expected to remain at that amount for each of the next 5 years. In the sixth year, it is expected that the payout ratio will be 80% of the earnings per share, and the payout ratio is expected to remain at that level forever. The required rate of return on Plutarch's ordinary shares is 20% per year and the latest earnings per share was 25 cents.

Required:

Calculate the price that Plutarch Corp. ordinary shares should be selling for in the market?

Answer 1

Year	EPS	DPS
0	$      0.25	$      0.10
1	$      1.25	$      0.10
2	$      2.19	$      0.10
3	$      3.83	$      0.10
4	$      6.70	$      0.10
5	$      6.90	$      0.10
6	$      7.11	$      5.69

Forecast the earnings per share and dividends per share for the next 6 years given the current earnings and growth rates.

Using constant growth model, Price in year 5, P5 = D6 / (r - g) = 5.69 / (20% - 3%) = $33.45

Price today, P0 = D1 / (1 + r) + D2 / (1 + r)^2 + ... + (D5 + P5) / (1 + r)^5

= 0.10 / 1.2 + 0.1 / 1.2^2 + ... + (0.1 + 33.45) / 1.2^5

= $13.74 is the current stock price.