Suppose that a firm’s recent earnings per share and dividend per share are $2.65

Question

Suppose that a firm’s recent earnings per share and dividend per share are $2.65 and $1.60, respectively. Both are expected to grow at 8 percent. However, the firm’s current P/E ratio of 17 seems high for this growth rate. The P/E ratio is expected to fall to 13 within five years. Compute the dividends over the next five years. (Do not round intermediate calculations. Round your final answer to 3 decimal places.)

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

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

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

Explanation / Answer

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Dividend Per share                   1.60                 1.73               1.87               2.02                   2.18              2.35 Earning Per share                     2.65                 2.86               3.09               3.34                   3.61              3.89 PV factor @ 10%                     1.00               0.909             0.909            0.909                0.909            0.909 PV of DPS                 1.57               1.70               1.83                   1.98              2.14 b Total PV of DPS $               9.22 PV Of EPS                 2.60               2.81               3.03                   3.28              3.54 Total PV of EPS $             15.26 a P/E ratio at Year 5 =13 Price /EPS=13 Price =13*EPS=13*3.89=50.62 So Stock Price in 5 years =$50.62

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