Suppose that a firm’s recent earnings per share and dividend per share are $2.50 and $1.30,...

Suppose that a firm’s recent earnings per share and dividend per share are $2.50 and $1.30, respectively. Both are expected to grow at 8 percent. However, the firm’s current P/E ratio of 22 seems high for this growth rate. The P/E ratio is expected to fall to 18 within five years.

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

First year $

Second year $

Third year $

Fourth year $

Fifth year $

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

Find Stock price:

Calculate the present value of these cash flows using a 10 percent discount rate. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Find Present value:

Please answer all the parts correctly. Thanks in advance!

Solutions

Expert Solution

Year	Dividend
1	1.404
2	1.516
3	1.638
4	1.769
5	1.910

Value of stock in year 5 = PE Ratio*EPS = 18*3.673

= 66.12

Present value of the cash flows = 1.404/1.1^1+1.516/1.1^2+1.638/1.1^3+1.769/1.1^4+1.910/1.1^5+66.12/1.1^5

= 47.21

Workings

Year	Dividend	EPS	Price at Year 5
1	1.404	2.700
2	1.516	2.916
3	1.638	3.149
4	1.769	3.401
5	1.910	3.673	66.11976

jeff jeffy answered 7 months ago

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