Justin Cement Company has had the following pattern of earnings per share over the last five years: Year Earnings per Share 20X1 $ 4.00 20X2 4.24 20X3 4.49 20X4 4.76 20X5 5.05 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.
a. Project earnings and dividends for the next year (20X6).
b. 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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Dryomys Dryomys · Answer 1 · 2020-03-04T10:48:18+01:00

Answer:

(a) $5.353; $2.1412

(b) $30.59

Explanation:

Given that,

Year Earnings per Share

20X1 $4.00

20X2 $4.24

20X3 $4.49

20X4 $4.76

20X5 $5.05

Dividends = 40 percent of earnings

Constant growth rate for earnings:

= [tex]\frac{EPS\ for\ any\ year}{EPS\ for\ the\ previous\ year} - 1[/tex]

= [tex]\frac{4.24}{4} - 1[/tex]

= 1.06 - 1

= 0.06 or 6%

(a) EPS for 20X6:

= EPS for 20X5 × (1 + 6%)

= $5.05 × 1.06

= $5.353

Dividend for 20X6:

= 40% × EPS for 20X6

= 40% × $5.353

= $2.1412

(b) Given that,

Required rate of return (Ke) = 13 percent

Stock Price at the beginning of 20X6:

[tex]=\frac{Dividend\ for\ 20X6}{(Required\ rate\ of\ return - Constant\ growth\ rate)}[/tex]

[tex]=\frac{2.1412}{(0.13 - 0.06)}[/tex]

= $30.59