Chapter 4: Q31BP (page 326)

Question:Justin Cement Company has had the following pattern of earnings per share over the last five years:
Year Earnings per Share
20X1 ................... $5.00
20X2 ................... 5.30
20X3 ................... 5.62
20X4 ................... 5.96
20X5 ................... 6.32
The earnings per share have grown at a constant rate (on a rounded basis) and will continue to do so in the future. Dividends represent 40 percent of earnings.
Project earnings and dividends for the next year (20X6).
If the required rate of return (Ke) is 13 percent, what is the anticipated stock price (P0) at the beginning of 20X6?

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Answer

The anticipated price is $38.28

Step by step solution

$\begin{array}{rcl} EPSof 20 X 6 & = & EPSof 20 X 5 \times (1 + GrowthRate) \\ = & 6.32 (1 + 0.06) \\ = & $ 6.70 \end{array}$

$\begin{array}{rcl} dividend of 20 X 6 & = & EPS of 20 X 5 \times Percentage of Dividend \\ = & 6.70 \times 40 % \\ = & $ 2.68 \end{array}$

$Anticipated Price (P 0) = \frac{D 1}{(Requiredrateofreturn - GrowthRate)} = \frac{2.68}{(0.13 - 0.06)} = $ 38.28$

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