Georgetown Motorcars (GM) common stock currently is selling for $71.44, which is

Question

Georgetown Motorcars (GM) common stock currently is selling for $71.44, which is 19 times its EPS, the most recent dividend paid by GM was $2.00 per share.

a. What is GM's current EPS?

b. What is GM's current dividend payout ratio? (Hint: The payout ratio refers to the percentage of earnings that is paid as dividends.)

c. Assume that investors require a 12 percent return to invest in GM's stock. Compute both the dividend yield and the growth provided by GM's stock. (Hint: The dividend yield is the dividend by the current market price of the stock.)

d. The industry P/E ratio normally varies from around 11x to 14x. Using these industry averafes, estimate the price at which GM should sell.

Explanation / Answer

Part A

EPS = Price per share / Price to Earnings Ratio

= $71.44 / 19

= $3.76 per share (Answer)

Part B

Dividend payout ratio = Dividend per share / Earnings per share

= $2.00 / $3.76

= 0.5319 or 53.19% (Answer)

Part C

Dividend yield = Dividend per share / Price per share

= $2.00 / $71.44

= 0.0280 or 2.80% (Answer)

Growth Rate = Return on Equity x Retention Ratio

= ROE x (1 - Dividend payout ratio)

= 0.12 x (1 - 0.5319)

= 0.12 x 0.4681

= 0.0562 or 5.62% (Answer)

Part D

Price = P/E Ratio x EPS

At P/E Ratio:

11 times = $3.76 x 11 = $41.36 per share

12 times = $3.76 x 12 = $45.12 per share

13 times = $3.76 x 13 = $48.88 per share

14 times = $3.76 x 14 = $52.64 per share

Thus, the share should sell between a range of $41.36 to $52.64 (Answer)

Looking at the industrial P/E Ratios, it seems that the stock is overpriced.

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