Suppose that a firm’s recent earnings per share and dividend per share are $2.30
ID: 2749484 • Letter: S
Question
Suppose that a firm’s recent earnings per share and dividend per share are $2.30 and $1.30, respectively. Both are expected to grow at 7 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 and round your final answers to 3 decimal places.)
Compute the value of this stock in five years. (Do not round intermediate calculations and round your final answer to 2 decimal places.)
Calculate the present value of these cash flows using a 9 percent discount rate. (Do not round intermediate calculations and round your final answer to 2 decimal places.)
Suppose that a firm’s recent earnings per share and dividend per share are $2.30 and $1.30, respectively. Both are expected to grow at 7 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.
Explanation / Answer
Dividend over the next 5 years
Value of the stock in five years = P/E ratio * EPS
EPS after five years = $2.3 * (1.07)5 = $3.22586898
P/E ratio after 5 years = 18
Therefore, value of these stock in 5 years = 18*3.22586898 = $58.06564164 i.e. $58.07
Calculation of Present value of these cash flows
PV of dividends
Year 1 = 1.391 * 0.917431192 = $1.276146788
Year 2 = 1.488 * 0.841679992 = $1.252419828
Year 3 = 1.593 * 0.772183478 = $1.23008828
Year 4 = 1.704 * 0.708425209 = $1.207156556
Year 5 = 1.823 * 0.649931384 = $1.184824913
Therefore, PV of dividend = $6.150636365
PV of stock price = $58.07 * 0.649931384 = $37.74151546
Total PV = $6.150636365+$37.74151546 = $43.89215182 i.e. $43.89
Year Dividends 1st year $1.391 (1.3*1.07) 2nd year $1.488 (1.391*1.07) 3rd year $1.593 (1.48837*1.07) 4th year $1.704 (1.5925559*1.07) 5th year $1.823 (1.704034813*1.07)Related Questions
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