Suppose that a firm’s recent earnings per share and dividend per share are $2.50 and $1.50, respectively. Both are expected to grow at 9 percent. However, the firm’s current P/E ratio of 24 seems high for this growth rate. The P/E ratio is expected to fall to 20 within five years.
Compute the dividends over the next five years.
Compute the value of this stock in five years.
Calculate the present value of these cash flows using an 11 percent discount rate.